Markets in the US, Germany and the UK have been rallying strongly over the last five years, with most doubling from their 2009 lows. But emerging markets have undergone a turbulent time in this period. We have had good years 2009 and 2010, followed by an extremely tough 2011, a good 2012 and an average 2013.

So, it is difficult to say when the bull market started in the emerging markets.

However, for India, it started only this year. This is because the rally prior to 2014 was led by either defensives or stocks that derive growth from overseas markets, for instance, IT and pharmaceuticals.

Zero interest rates Let us consider the global scenario first. It is very clear that the global bull market cannot end when major economies have zero interest rates.

Today we have a scenario where the overnight rates are zero in the US, the UK, the Euro Zone and Japan. The first expected increase is likely from the US, that too 15-18 months down the line. The Euro Zone is still grappling with fears of deflation; same is the case with Japan.

So, at what level of Fed funds rate should we start getting worried? My guess is that till the overnight rate in the US reaches a level of 3 per cent and the US 10-year bond yields 4-4.5 per cent, the bull market in equities will continue. This is because rates go up due to the possibility of stronger growth. Stronger growth is good for equity markets.

The second factor then is that at what level of interest rates will growth prospects start looking dimmer. That should be around 200 basis points above the current US 10-year bond yields of 2.5 per cent.

At that stage, depending on the stance of the ECB, Bank of Japan and other central banks, we will need to take a call on the direction of the markets. However, this is still three years down the road.

Growth revival in India Looking specifically at India, my view is that the bull market started after the massacre of the small- and mid-cap stocks. Small- and mid-caps got smashed in 2008, whacked in 2011 and finally destroyed in 2013.

This was the time when people lost total hope in equities in India and redemptions from domestic MFs reached a crescendo. The outflow from equities in general and a shift into other assets such as gold, tax-free bonds and real estate also reached a peak.

Most people tend to believe that as interest rates in the US move up, they will move up in India too. This is not necessarily true. The difference between the 10-year bond yields in India and the US has swung between as low as 0.5 per cent and as high as 6.5 per cent over the last 10 years.

Fiscal prudence, combined with lower inflation, can create a situation where Indian interest rates can actually decline even as they increase in the developed markets.

Inflation is now on the way down and the new Government is focussed on growth revival along with inflation control by a combination of fiscal constraint and boost to the supply side. These factors are positive for growth revival.

The growth revival cycle in India is just starting. We saw a bottoming of growth at 4.5 per cent last year. This should swing back to 6 per cent this year and 7-8 per cent over the following three years.

Stock markets Stock markets will always do well in a period of accelerating growth. Every economy goes through phases of profit expansion and compression while the GDP and the turnover (sales) of companies continue to grow.

The phases of profit expansion make profits grow faster than sales. As profits grow more than the turnover of the companies, the return on networth or the return on capital also moves up.

This leads to an upward re-rating of the companies in that economy as the outlook for future growth looks positive. During this phase, the market capitalisation to GDP ratio of the stock market expands.

India’s market capitalisation to GDP reached a level of 60 per cent last year. This currently stands at 85 per cent.

The case for expansion in India’s market cap to GDP, going forward, is extremely strong. The ratio moved up from 45 per cent in 2003 to 160 per cent by the end of 2007 in the case of India.

If it moves back to a level of 120 per cent over the next five years and in the same time period we have a nominal GDP growth of 11-12 per cent, the calculation reveals a 125-150 per cent return potential in this scenario over the next five years — that is, Nifty above 18,000 and Sensex above 60,000.

The writer is a business consultant

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