LAYING THE FOUNDATION OF A SUSTAINED BULL RUN

The Indian markets have been on a continuous uptrend since the beginning of 2014, as positive events at different interval have fuelled the growth momentum. It started with some of the serious decisions taken by the UPA II government towards the end of its tenure, to revive the Indian economy after a continued policy paralysis during 2012 and 2013 on account of several scams which emerged one after another and led to the lowest GDP growth rate in the last decade. Then came the strong moves from the new RBI governor which not only contained inflation but also restricted the volatility in INR.

Thereafter results of the General Elections wherein the Indian public after a long time elected a party (BJP lead NDA government) with a clear majority/ mandate.  The new government under the strong and bold leadership of Mr Narendra Modi, after taking oath announced initiatives and policy action which were well accepted by the markets and FIIs gained confidence in the Indian financial markets, as they felt that steps taken by the new government are in the right direction and paving the road for the GDP to inch back to a higher growth orbit i.e. towards early double digits.

In the meanwhile steep correction in crude oil and softness in gold and silver prices has helped to contain the current account/ trade deficit, which is also a positive factor the markets to cherish. Off-late the RBI in its surprise move in Jan 2015 had announced a rate cut of 25 bps which was long awaited by the markets. This has resulted in many taking a view that the reversal in interest rate cycle has began and capex revival is in the offing (providing momentum to PM Modi’s initiative to boost manufacturing sector through its campaign “Make in India”), also the rate sensitive sectors such as real estate and infrastructure or companies with high leverage will stand to benefit the most.

Indian Markets on an Upbeat Roll

The BJP-led NDA government at the Centre is progressing fast on the road map which it has laid during the general elections, in regards to provide boost to the economic growth through overall development and for this it has given strong signals both in the domestic market and to the international community by passing certain bills on issues such as coal mining and insurance through the ordinance route and also is going ahead with the spectrum auction and disinvestment process to raise funds to contain the fiscal deficit as projected. The current government has also stated and made it clear that it will not contest or open cases in respect of retrospective taxation, as was the case with the previous government at the Centre which has send tremendous terror waves to the foreign investors who had pumped in huge money.

This has once again sent positive signal to the foreign investors who have once again started looking at the Indian Markets, after the formation of new government. Their confidence on the Indian government and the Indian markets has risen an inch further.  The government also intends to get the land acquisition bill and GST Bill approved at the earliest as both the bills are crucial and will provide a flip to the development and growth rate.

All the key factors such as government policy actions, contained inflation, steady INR, lower crude prices, reversal in interest rate cycle etc all indicates that there is expected to be robust revenue growth visibility (higher consumer confidence to lift demand) in quarters to come and which will also be supported by margin expansion (lower input and funding cost).  These will lead to earnings upgrade and also result in multiple expansions thereby rerating of the Indian markets which seem to be structurally on the Bull Run if the above things fall in place as expected.Uday Kotak, Executive Vice Chairman & MD, Kotak Mahindra Bank on the sidelines of the launch of the book ‘The Making of India’ explained that “India story is more of like a marathon and it’s not a sprint. We have the ability to run marathon and we need to run. The current market believes in our ability and hence it is priced in current valuation of indices”

Union Budget and the Stock Market

Lot of factors influence the movement of stock market throughout the year, however there is a high probability that budget plays a key role in the movement of the markets during the pre and post budget period. The Union budget is an important event as lot of policy action takes place at the government end which sets the direction for the whole year as to how the government will manage its finance and how will it boost economic growth and development. With the expectation of industry demanding certain sops and incentives to provide boost to the economic growth flowing around the market during the pre budget period, and the proposals of the industry being met or rejected by the finance minister during the budget paves way for the markets to react accordingly.

Though there has not been an instance in the past which has given a pre-budget (one month) rally of more than 5 per cent, however post budget (one month) a rally of more than 5 per cent has been witnessed on many occasion. However the current year is somewhat different from the past on many from, like inflation under control, stable currency, reversal of interest rate cycle, fiscal deficit contained as projected and GDP showing signs of recovery after a disasters performance in the last couple of years.Uday Kotak explained that “the current budget must present the roadmap for next five years for country and moreover policy change is a continuous process and not only budget specific”

Also, the most important thing to watch out for is that it will be the first full-fledged budget of the BJP led NDA government who has attained full majority to whom the Indian public at large has given such mandate after a long time 3 decades. The expectations are high from this government and it has also shown its willingness and intention to fulfill the promises which it has made by taking bold decision and initiatives during its 9 months tenure.  It is expected that the finance minister might surprise everyone including the markets by laying out the Union Budget in such a manner which is a balanced one and pleases everybody without hurting the government finances.

The key factors based on which the Indian markets is poised to show fantastic returns over the next  few years, as it is riding on the bull run have been stated below and their relevance have been explained accordingly.

Improvement in Indian GDP growth rate: After the formation of new government in 2014, the Indian GDP growth rate is showing signs of recovery as there is an improvement in sentiments and business environment. A lot of other factors are also playing in favour (discussed below) which is providing boost to the Indian economy. The new government is trying hard and its level best to provide a flip to the Indian economy which has been on a downturn during the UPA II regime.

The previous NDA government in 2004 had handed over the Indian economy in good shape to the UPA I government and the market had seen huge momentum which had seen a bull run with Sensex scaling from around 5000 to 20000 between 2004-08. However the case has been different in 2014 wherein the UPA II government has handed over the Indian economy to the NDA II government in terrible state. Despite this as the Indian public at large had given a thumping majority to the BJP led NDA government, hope are high from this government and it is expected that the GDP growth rate may scale back to early double digits by 2019.

Improvement in fiscal deficit: The fiscal deficit has been widened quite sharply during the early years of UPA II tenure (however they tried to narrow it down during the end of its tenure, but mainly by cutting on the spending which hampered economic growth activities), as there was a slowdown in the economy as a result of policy paralysis mainly due to appearance of scam one after another involving the ministers of the UPA II government. This resulted in a scenario wherein rating agencies where keenly watching the situation for a sovereign rating downgrade.

The investor confidence remained low on account of this and hence where shying away from the Indian markets during such period. The socialistic moves by the UPA II government led to a huge outflow on one hand and inflow was constrained on the other hand due to poor tax collections due to low economic activity and disinvestment target not being met due to low investor confidence.

However the situation seems to be improving with new government taking bold steps to revive the economic, which will boost tax collection and also the investor sentiments and confidence has improved a lot which has help the government to move ahead in its disinvestment program. 

As a result of which the government has been able to contain the fiscal deficit as projected and is further anticipated that fiscal deficit will reduce going forward as well. This might provide a comfort and boost to the foreign participants investing in India as the rating agencies have turned also optimistic on India post the formation of the new government in 2014 and considering the steps taken by the government seems to be in the right direction.

Inflation within comfortable levels: Though the RBI governor both Mr D Subbarao and his successor Mr Raghu Ramrajan has been criticized by many in the political and business circles for not lowering the interest rates which has been hurting the country’s growth but the RBI governor was facing challenge to lower the giant dragon – inflation  which was now and then setting its head high mainly due to excess liquidity at some point of time and supply side bottlenecks on the other instances besides adverse monsoon in few years. Also higher commodity prices and depreciating currency has been a key factor which led to high inflation as India has been largely depended on imported crude of its energy requirement.

However the RBI governor through his wise decisions and wisdom has been successful in taming the inflation and bringing it within a comfortable level for a sustained period of time by keeping the interest rates unchanged, intervening at certain instances to stabilize huge fluctuation in currency. Also the steep fall in commodity prices has been an added advantage for lower inflation which is expected to remain southbound or stable at current levels

Stable currency: There has been sharp volatility in currency from mid 2011 to mid 2013 with INR on a depreciating trend due to various factors such has growth in developed countries; action by the Indian government in terms of retrospective taxation, outbreak of several scams resulting in slowdown in Indian economy, widening of fiscal deficit and chances of rating downgrade etc, however the INR has been stable since then due to various factors intervention by the RBI, improved economic environment, formation of new government with full majority, investor confidence on the rise and decision of the new government not to move ahead in respect of retrospective taxation.

Correction in commodity prices to boost margins: India is largely depended on imported crude for its energy requirement hence high crude prices results in a completed disadvantage as it increases the import bill, depreciation in currency, increase in fiscal deficit, contraction in margins etc which has been witnessed during the 2009 to 2013 period, however with steep correction witnessed in crude during the end of 2014, its seems to be a boon for India as everything is falling in place to take India to its glory days with high GDP, low inflation, high revenue growth visibility and improved margins. These above factors will spice up the investor confidence which will start looking at India with renew interest and confidence.

Reversal in interest rates cycle: As stated earlier, the RBI governor had a tough job of bring mounting inflation to a comfortable level for a sustained period of time for which it had to maintain its hawkish stance and face criticism from every corner. However, efforts of the RBI governor have shown positive signs and he has been successful in taming the inflation. This may have impacted the economic growth rate with capex cycle being on a standstill. The recent surprise by the RBI governor with a 25 bps rate cut has made it clear that the reversal in rate cycle has began with people hoping for a 50-75 bps cut in the next 12 months. This will not only revive the capex cycle but will also boost consumer spending as the lending rates would be lower (housing, auto, personal loans). The economy will surely receive a mileage out of it as the inflation is also under control.

Revival of capex: With inflation under control, reversal in interest rate cycle on the door, it is expected that there is a revival of capex cycle in the making both from the private sector as well as the public sector, which will not only boost manufacturing activity but will also drive up employment opportunities. This was on a standstill since long due to various factors some of which have been discussed above but things are looking better and greener now. Also to meet the rising demand certain companies may face capacity constraints, hence to remove bottlenecks in terms of volume growth these will be bound to undertake capacity enhancement.

Improved consumer sentiments: With inflation under control, interest rate in reversal mode, revival in capex cycle which will boost job creation all will result in improved consumer sentiment thereby increasing the spending power of consumers. This will boost the revenue visibility of companies.

Revenue visibility:  The revenue visibility of companies has increased post the formation of new government, as things have started rolling back with new confidence and positive vibes provided by the government to boost economic growth at a faster pace as the country has been behind for certain number of years due to policy paralysis during the UPA II tenure.

Earnings upgrade: Higher revenue visibility coupled with lower commodity prices will help in operating margins improvement going forward. This coupled with lower interest rate regime will improve PAT margins and warrant and earnings upgrade for most of the companies for FY16 and FY17.

Valuation: With all positive things happening around the Indian markets seems to be on a bull run for a long tenure as hope are high on the new government which is trying to boost economy as earlier as possible. Factors explained above warrants a rerating of Indian equity markets with scope of multiple expansion as the future looks bright from a long term horizon.

Expected increase in FII/MF net inflows: With improvement in investor confidence in the Indian equities post new government formation the net inflow of FIIs and MFs is expected to surge going ahead to en-cash on the expected multi-year bull run. India has been one of the favorite destination for investors  which has been pouring in money as the Indian markets have been providing superior returns in the past baring a few years.

Some Key Concerns

Though the long term picture looks rosy, however there might be thorns in the form of slight correction and consolidation in markets if events go the other way round at different intervals but for a short term. This could be either due to international factors or domestic factors or a combination of both. Some of the factors which could have an adverse bearing on the markets could be liquidity being diverted to other emerging nations, unfavorable action of the central banks of developed nations, steep rise in commodity prices, political uncertainty, crisis situation due to ISIS, Euro zone crisis on the international side.

However on the domestic front issues such as unfavorable monsoon, announcement and policy action of the government not materializing on the ground as expected, delay in rate cut and inflation on the rise etc. Also the recent disinvestment program of the government is expected to suck in the liquidity which might result in markets to witness some slowdown in its upward momentum. Hence we advice our readers to stay invested in good quality stocks and accumulate them further on dips, however would like them to book profits on stocks which are highly volatile in nature and are high beta stocks.

Conclusion

Though there could be some instances or events as stated above in above paragraph which could result in a slight correction or consolidation in the ongoing bull run, however we believe that post the formation of new government and steps which it has taken most of the things have been falling in place such as low inflation, low commodity prices, stable currency, contained fiscal deficit,  reversal in interest rate cycle, other things such as revival in capex cycle, growth in GDP, visibility in robust revenue growth and improvement in margins will fall in place going forward which will warrant a rerating and multiple expansion of the Indian equities.

The factors are expected to keep the FII money flowing into the Indian equities which will drive up the markets further and sustain the Bull Run. Hence we advice the reader to be optimistic and stay invested in the Indian equities; however remain cautious on certain occasions to accumulate good quality stocks on dips and exit high beta stocks on upsides swings.

Nirmal Jain, Founder and Chairman, IIFL Group

“On an average I expect 20%-25% returns comfortably in 2015”

1.     How do you see the equity market returns for CY15?

I am quite optimistic and believe 2015 would be a good year for Indian equities. On an average I expect 20-25 per cent returns comfortably and in bright scenarios it can go up to 30 per cent also. I would be very hopeful about next year primarily because I am expecting a significant increase in earnings. Not only because of the stability on political front but also because of the crude oil and the commodity prices going down and that being the raw material for most of the companies will improve the profit margins.

2.      How do you see FIIs inflow in the current year?

In terms of FII flows, India is likely to remain one of the most attractive destinations. Considering the availability of fund for emerging markets and India’s improving macro environment, the country still remains an attractive buy valuation wise. If the valuations are attractive, the economy is looking good then within the emerging market basket India will get a relatively higher allocation in 2015.

3     What are the sectors or stocks you are currently betting upon?

In 2015, I believe banks will be one of the key primary drivers because this crude oil and inflation will have an impact on interest rates. We already have a surprise rate cut in January and though the central bank kept the repo rate unchanged in February we expect a series of rate cut action by the Reserve Bank of India going ahead. As lending rates as well as deposit rates will head southwards banks will be one beneficiary. I would look at auto companies I would also look at IT and pharma pack because we may have our domestic strength but dollar is strengthening for different reasons and IT companies in terms of valuations still are not very expensive and in fact they are also good hedging bets in the portfolio. I would make a mix of cements, auto, IT, pharma and banks for 2015.

Response by Mr. Motilal Oswal, Chairman and Managing Director, Motilal Oswal Financial Services

India Will Continue To Attract Foreign Money

1.      What is your outlook on the Indian markets for 2015 in the current environment? How do you compare it with other emerging markets?

We remain positive on Indian markets for 2015, we may see tempered returns but overall trend should remain positive and earnings will get broad based. India to our mind remains one of the best emerging markets in the current scenario. Combination of political leadership, demographics and commodity tailwind places us better than majority of the emerging markets. Looking at current enthusiasm from FII we believe that India will continue to attract foreign money.

2.      What are your views on the Q3FY15 results (till date) and how do see Q4FY15 results panning out going forward?

So far results have more misses than surprises but earnings are bottoming out and we believe that 2HFY16 will kick in an upgrade cycle. 4Q will be comparatively better than 3Q as the inventory adjustments amidst the commodity volatility and channel restocking will improve the business environment.

3.      RBI has surprised by a 25 bps rate cut recently, what is the quantum of rate cut expected in CY15 and how much market momentum is expected on account of this.

We believe that there is room for more rate cuts and we can guess that it can be around 50bps to 75bps more. Monetary policy will maintain its stance and direction so models have started to factor in the rate easing cycle. The timing and extent of the rate cut can surprise the market, if our currency environment remains stable, adding fuel to the fire. So, one thing is certain that interest rates are southbound.

Only quote

“ India story is more of like a marathon and not a sprint. We have the ability to run marathon and we need to run. The current market believes in our ability and hence it has been priced in current valuation of indices”

Uday Kotak, Executive Vice Chairman & MD, Kotak Mahindra Bank