Lessons from the past
- Stock markets are volatile in the short term and it is hard to forecast short term movements.
- Stock markets in India are growing in line with nominal GDP growth over longer periods i.e., 12-16% CAGR.
- Best performing and worst performing sectors tend to change every few years.
- Unlike elections, where the majority opinion always wins, in stock markets, majority can be wrong if its logic or rationale is incorrect. For instance, IT that was wildly popular in 1999 and enjoyed a nearly 100% fan following, underperformed massively over the next few years. On the other hand, a uniform dislike for banks, capex, metals around 1999-2000 could not prevent these sectors from delivering 5-30 times returns over next several years.
Current situation
If one reads the headlines over the last few months, the impression one gets is that the economy is passing through challenging times - GDP growth is slow, earnings growth is low and is not supportive of markets.
However, the comment by many that markets are expensive etc., is not borne out by P/E multiples as the following table clearly suggests.
|
PE for |
FY17 |
FY18E |
FY19E |
FY20E |
|
as on Sep 30 |
22.2 |
21.8 |
17.3 |
14.7 |
Source: Kotak Institutional Equities, E-Estimated
Going forward
GDP growth - sharp improvement ahead
GDP Growth has indeed slowed down in last few quarters. However, this is, in all probability driven by demonetisation and GST, two very significant reforms that have caused temporary disruption in the normal functioning of the economy. However, as things normalise, growth rates are expected to recover smartly over the next few quarters. Monthly data for July, August and September for several parameters already points in that direction.
The medium term outlook for the economy is even more encouraging. This view is driven by a likely acceleration in infra capex, affordable housing and a revival in private capex. As per recent news flow, there are reasons to be optimistic about revival of private capex in the not too distant future primarily led by metals sector.
One more important point that needs to be explained is the low growth in mature categories. As a country and society progresses, certain categories of goods become increasingly affordable and penetration therefore increases.
Earnings recovery is imminent
Expectations in financial markets move much faster than the real world. It typically takes two years to build a house, one year to renovate it, but we expect the economy growth to surge, NPAs to resolve, earnings to recover and much more in few quarters. Unfortunately, to bring about changes in the real world and more so in a large and complex country like India takes longer. Besides the environment is not static and sometimes while you fix one problem, another one crops up. Take for instance the fall in steel prices to near 15-year lows in 2015 unexpectedly. This set back not just the steel sector but also the banks by a few years.
The earnings disappointment in recent past has been weak mainly due to the sharp fall in profits of sectors like steel, engineering & capex and corporate banks. This however, is all set to change.
With the sharp recovery in steel and other metal prices, with the peaking of provisioning costs in banks and with a slow but steady improvement in infra capex, earnings recovery is underway and it should become increasingly evident with each passing quarter.
Promising markets
Index has trailed nominal GDP growth by 8% p.a. for last 10 years (SENSEX CAGR of 6% vs Nominal GDP growth at a CAGR of 14%). As a result, India’s market cap to GDP on CY18 is 72%, which is low. This will be lower still for next year.
Even in terms of p/e, markets are reasonably valued. In fact, as earnings growth improves, the p/e's should look more reasonable and move lower.
New sectors should lead earnings growth over next few years
It is interesting to note that there is a significant divergence in the profit growth across sectors between the past and estimates for the future. For instance: profits for capital goods de-grew by 22% CAGR between March 12 and March 16, are expected to grow at a CAGR of 36% between March 16 and March 19. Similarly, healthcare, where profits grew by 20% CAGR between March 12 and March 16 are likely to grow by only 5% CAGR between March 16 and March 19. This divergence in profits between the past and future opens up prospects for new sectors to gain leadership in the markets going forward.
Final message
There is merit in increasing allocation to equities or in staying invested as the case may be (for those with a medium to long term view and in line with individual risk appetite). Successful investing needs more patience than intelligence. The track record of a few mutual fund schemes over decades and the experience of those investors who have stayed invested in these funds for long periods amply demonstrates this.
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