Looking forward to a secular Bull Run

By Nimesh Shah
Managing Director & CEO
June19th, 2014
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India has experienced a gradual improvement in its macro-economic indicators over the recent past. This is noticeable in the declining trade and current account deficits, and a deceleration in the rise of inflation.

These positive indicators, upbeat business sentiment and an expected improvement in corporate performance have seen a positive reaction from the stock markets. India’s gross domestic product (GDP) growth has increased at a modest pace in the past; it took us 60 years to achieve the $1 trillion mark in 2007. But from here on, with positive fundamental shifts in the economy, the rate of growth can heighten and we expect it to touch $5 trillion by 2025.

Growth will manifest in various forms. Two key aspects that augur well for India’s economic growth are its urban sector and infrastructure development.

India’s urban sector, which constituted about 45% of GDP in the 1990s, is today 63%. Urbanization, which is currently at about 31%, can accelerate. India is fortunate to have a population profile that is primarily within the working age bracket. The percentage of dependant population—senior citizens and children—has declined from 68.6% in 1995 to 52.4% in 2013, according to United Nations (UN) estimates. Combined with improved literacy rates (73% in 2011), India is well-positioned to offer the largest employable population to the world.

To facilitate economic growth, improving infrastructure will be one of the top priorities of the government. Higher spend in this area will increase employment, consumption and savings. In addition, this will provide further impetus to policy reforms.

Improving infrastructure will be one of the top priorities of the government. Higher expenditure in this area could increase employment, consumption and savings, and provide further impetus to policy reforms.

Policy reforms such as liberalization of foreign direct investment (FDI) limits in telecom and defence, allowing FDI in multi-brand retailing, civil aviation, broadcasting, reduction in fuel subsidies, divestment and passage of the land acquisition and the pension Bills would also give fillip to business sentiment.

Another growth impetus will be completion of existing projects that were incomplete due to want of funds. This will be especially effective in case of projects which involve lesser capital outlay, but improve capacity utilization. Another trigger is growth in India’s exports. India’s share of global exports has risen from a dismal 0.4% in 1981 to 1.75% currently. Higher exports will result in lower deficit, higher employment leading to more investible surplus, which, in turn, will reflect in stock market valuations.

For investors to benefit from this growth, investing in financial assets can be the way forward. In terms of equity investing, the Indian stock markets (as represented by the S&P BSE index) touched a high of 21,200 in January 2008; after more than six years, it has now crossed the previous high by a good margin. Meanwhile, during this time, the earnings of the 30 companies that comprise the Sensex have grown from Rs.833 crore to Rs.1, 295 crore, a 55.5% rise. Market capitalization of the Indian stock market (aggregate value of all listed companies), which was 103% of GDP in 2008 is now at a mere 60%.

Further, within equity markets, while the Sensex constituting large-cap companies has now fully recovered, mid-caps and smaller companies, represented by the BSE Midcap Index, have a long way to go in providing attractive investing opportunities.

Compared with the rapid growth in the Sensex, the BSE Midcap Index, which had touched 10,113 in early January 2008 is now only at 8,400 levels. Clearly, the mid- and small-cap space is a case for investing to get potential capital appreciation.

The sectors and themes that may reflect growth are banking, infrastructure, industrials, public sector units and the mid- and small-cap spaces. In addition, against their performance in the past, favourites such as consumer goods, pharmaceuticals, software and cyclicals may offer better value.

Companies and businesses that thrived largely due to rupee depreciation in the recent years are unlikely to be the winners. Likewise, the consumer space, which is already trading at 30 times earnings, looks far less attractive to many other cyclicals, which offer better value.

In fixed income investing, a long secular bull market can be expected. Any economy that is well administered will not have the kind of high interest rates that we have now. In the last 11 years (2002 onwards), interest rates have fluctuated between 10.4% and 4.75%. Between 2002 and 2004, the rate was gradually reduced (from over 10% to under 5%) and again in 2008 from about 9% to under 5%.

If our economy is managed more effectively, we can look forward to a significant decline in interest rates. This may not happen overnight, but over the next 2-3 years. There are, therefore, a lot of opportunities in the fixed income, particularly in the duration space. Long duration bonds hold a lot of value and investors should seriously consider duration-based funds.

At present, where India is at the start of a growth phase, physical assets such as real estate and gold will not generate the kind of returns they did. Investors would do well to move out of these assets and into financial assets.

With the hope that an El-Nino-like situation doesn’t arise, crude oil prices stay in control, that no geo-political events impact growth, a secular bull run may start providing attractive opportunities to equity investors with a 3-5-year year investment horizon as also to debt investors due to declining interest rates.