The year gone by….
2015 witnessed a paradigm shift in investment choice of domestic investors who preferred financial assets over physical assets. This change in investment pattern is expected to gain further momentum over the next few years. A similar trend was witnessed in equity markets with domestic inflows exceeding the foreign inflows for the year. Domestic equity markets reached all-time highs in the beginning of the year, however the last few months witnessed phase of consolidation for domestic equity markets given the global worries.
While broadly the equity markets were range-bound over the year, we believe India is extremely well placed for a faster economic growth, and resultant equity market returns. In fact, despite the recent fall, Indian equities have been amongst among best performing markets globally. India’s relative outperformance can be attributed to significant improvements in the macro economic situation which augurs well for the markets over the long term.
We believe India is in a sweet spot compared to the rest of the world.
In the history of financial markets, there will be very few markets like India which offer these kinds of edges over the rest of the world both on short and long term basis.
Overall, we believe in a world where growth is scarce, deflationary concerns are increasing and interest rates are trending upwards India provides a rare favorable blend of high and rising growth, supportive inflation and downward interest rate trajectory. Indian equities stand out amongst the best placed as a) Indian macro recovery would certainly gain traction in 2016, b) After years of sluggishness; we could witness meaningful sustainable earnings recovery in 2016 as the dual impact of operating and financial leverage plays out positively.
Having commented on the near to medium term market potential, we would also like to point out the long term potential from Indian markets, which should be the fundamental reason why investors should consider investing into Indian equities.
India the Big Picture:
Huge Wealth Creation Opportunity
India is currently the 9th largest economy in the world with a GDP of around $ 2 trillion and historical average growth rate of 12% to 15%. Even assuming a conservative nominal GDP growth rate of 12% and current INR/USD exchange rate, Indian economy is likely to double in USD terms over the next 6-7 years to 4 trillion US$.
This presents Huge opportunity of wealth creation in India in the next 6 years. India’s current Market Cap to GDP ratio is about 75%. Assuming market capitalization to GDP rises in line with other large markets to 100%, there is an opportunity of multiplying the current wealth by 2.5 times.
Structural story of India is intact:
While India is in the midst of cyclical recovery in terms of key macro variables (Inflation, interest rates and growth), structural factors for long term India story remains intact –
- Favorable demographics: In an increasingly aging world, India’s demographic profile stands out. A rising working-age population also means a substantial rise in savings, which is important to financing investments.
- Massive productivity led growth possible - Tremendous labor productivity scope led by increasing urbanization. India’s value addition in manufacturing is one of the lowest in the world compared to China, Japan and others. Thus, there is tremendous scope for productivity (both labor as well as capital) improvements which in turn will accelerate growth.
Excessive Fed tightening and Chinese hard landing continue to be the major risk in 2016. Global inflation surprise on either side, worsening global geopolitics, EM debt deflation and weather disruptions are some of the other events which will be keenly tracked by market participants.
We are focused on domestic recovery themes like urban discretionary, short cycle capex which can gain meaningfully from the expected revival. Urban Discretionary Spending, has started to show signs of revival in the festive season. Positive tailwind of lower inflation is driving a recovery in consumer sentiment in some categories and will have a positive impact on these investments in the fund. Organized retail, Hospitality Sector, Media and Entertainment sector are the key focus areas within the Urban discretionary theme. The short cycle capex segments have also seen in improvement in few areas like roads and power transmission. sector. Newer areas like Defence have started to contribute to order book improvements.
With the expected transition of domestic savings from physical to financial assets, financial services space especially private sector banks, NBFCs etc. can gain meaningfully. Changing consumption habits of the Indian middle income households can offer interesting plays in emerging areas like hospitality, brands etc. FMCG, Utilities, upstream petroleum are a few sectors we do not have much exposure at present.
Our overall focus is on investing companies with high ROEs or strong earnings visibility with good corporate governance standards, while avoiding companies which are highly leveraged or have fractured balance sheets.
We believe Indian equities offer an attractive investment opportunity given that the earnings are at a cyclical low with many enablers in place which can allow for a sustained recovery. Further given the low earnings base, future earning shifts can be meaningful enhancing shareholder returns. The current market valuations are close to historical averages and there are many interesting investment opportunities across themes.
To conclude, in every growth story, there will always be short-term challenges. However, our advice for investors is to focus on the big picture and while keeping an eye on the near-term events on the horizon, please don’t get carried away by them. We maintain our positive stance on domestic equities and believe the asset class can be one of the best performing over the medium term.
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