Just a few months ago our economy was in the midst of a vicious cycle of low growth, high inflation, high interest rates and low capital expansion, one feeding on the other. But these variables are now changing and a virtuous cycle is beginning, with growth looking up, inflation slowing down and an improving investment cycle.
The improvement is the result of a pick-up in the economy, benign global commodity prices, and a stable Government. It is but natural that the equity markets reflect these trends.
We believe that the current uptrend seen in the equity markets is the beginning of a long-term rally which should last a few years for three reasons.
Upgrades ahead
One, while the country’s growth rates will continue to remain sub-6 per cent in the current year, they are expected to improve over the next few years if the Government successfully executes the initiatives that it has identified. This can result in a re-rating of the growth rates and corporate profitability. While the equity market has factored in some of these variables, earnings upgrades can sustain the uptrend.
Retail participation
Two, we have already started seeing retail investor participation in equities, both through direct investments and mutual funds, over the last few months. This participation has so far been limited to a few smart high networth investors. It is real retail participation that will drive the next stage of the rally.
In recent times, while foreign investors were investing in India, Indian mutual funds and institutions were selling into the rally, forced by redemptions from their retail investors. Now, both overseas investors and Indian institutions may remain buyers, resulting in higher demand for Indian equity. Yes, returns in the equity markets have always been lumpy and come with steep intermediate corrections. But one should not get perturbed by this and should use this volatility to one’s advantage.
Broad-based growth
Three, while the headline indices (Sensex and Nifty) are important, they aren’t the entire market. Just to put things in perspective, while the markets have risen 25 per cent, many domestic MFs have delivered 50 per cent plus returns. There are many stocks and companies beyond the ones in indices, which have not participated in the ongoing upturn owing to the not-so-conducive environment for their businesses. Now, with the overall environment improving and the capex cycle expected to look up, earnings growth may be broad-based. Therefore, the performance of the wider market can be expected to pick up pace and get in sync with the index performance.
(The author is Managing Director of Aditya Birla Money Ltd)