Bull Run Fuelled By Fundamentals & Flows

Indian equities have rallied since the third quarter of 2013, surprising most participants. Equities overcame uncertainties related to withdrawal of quantitative easing (QE) as well as the general elections and a slowing economy. Gradual QE withdrawal by the US was expected to reduce flows to emerging markets, including India. But the high level of existing liquidity in the US and Japan and EU’s loose monetary policies have ensured robust flows. The developed world has excess liquidity and near-zero interest rates. As long as the Indian economy assures better growth prospects and governance standards, global flows will continue.

The 2014 election verdict has raised expectations of appropriate government responses. Indian equity markets have risen from cheap valuations of about 12-13 times forward earnings in Q3 of 2013 to the current level of 16-17 times. This range is a little more than the average of the past 20 years, and is partially led by global and local flows. Global flows have come to India partly because they can’t go to Russia due to the Ukraine crisis, or to China due to the credit bubble and governance issues, or Brazil as the economy is in recession or Thailand, Indonesia and Turkey due to their individual political scenarios. Local flows that came as equity outperformed Ifixed income, gold and realty in the past 12-18 months. I expect flows to continue from the domestic side as equity is under-allocated by Indian investors. Also, flows from foreign investors will come in despite the premium valuation Indian markets are enjoying over their peers.

Equity markets are supported by the improving macroeconomic scenario. Oil is now in double digits, the monsoon has recovered, inflation is moderating, the rupee is stable, first quarter GDP growth at 5.7 per cent is the highest in two years, current account deficit is in a comfortable range and the fiscal deficit is under check. The market is expecting the Indian economy to be on a sustainable growth path. Many local investors want to invest on a correction. However, it is unlikely the markets will allow them to enter at lower levels.

That said, equity markets will have their share of volatility. But all those corrections will provide great opportunities to invest. India is in the midst of a multi-year bull run backed by fundamentals and flows. While investor flows are improving, they are likely to be polarised towards blue chip and free-cash-flow-generating firms even at aggressive valuations.

There will also be increased activity in primary (IPO) and secondary (QIP/ OFS) offerings. Divestment of PSUs by the government will be one source of supply; offerings from the BFSI sector, another. India Inc., which has not raised equity capital for growth or de-leverage, will provide supply as valuations turn attractive with availability of cash. Supply of paper from divestment and the BFSI sector and India Inc. looking to deleverage or raise capital will calm the markets. The primary market, which has seen a strong revival, as reflected in the over-subscription of recent IPOs should become more active. There is no better catalyst to bringing retail investors into the equity market than a good IPO.

While sentiment is upbeat, the investment cycle will take time to revive. To some extent, the investment cycle will be backed by a massive shift in the savings pattern in favour of financial savings and improvement in project execution. Considering the time gap in executing a project, the investments cycle is likely to impact growth over the medium term rather than the short term. While an across-the-board market rally may be behind us, a stock-specific approach will still provide attractive returns. Investors should be overweight on large-cap stocks of quality companies. They should invest in non-leveraged companies generating free cash flow and available at reasonable valuations. We also recommend investors be overweight on technology and banking and financial services. For retail investors, a systematic investment approach will be the most appropriate way to participate in the current market.

The author is managing director and CEO of Axis Capital

(This story was published in BW | Businessworld Issue Dated 06-10-2014)