That the stock market in India is on a roll could well be an understatement. From the low of 7,511 hit in March 2020, post the COVID-19 scare, the Nifty now trades at 14,645. In terms of 12-month forward P/E, it is trading at 21.4x with the 10-year average being 18.8x. The disparity is even higher on 12-month trailing P/E basis where it is trading at 27.7x with the 10-year average being 19.9x. This all-time high comes on the back of a continuous pullback which most domestic institutional investors have sold into. If one looks at mutual fund activity for CY20, they have turned net sellers after five years (See: Selling into the rise). Conventionally, the domestic fund managers’ reading of ground reality has always trumped that of foreign investors. How is it going to turn out this time? Will stock market investors have enough to smile about in 2021? Is the Nifty on course to scale 15,000 and beyond? To ask that dreaded question, ‘Is it different this time?”
Shankar Sharma, co-founder, First Global puts the runaway rally in perspective and says what we have seen so far is not a fairy tale run. He says, “India has been at the bottom-end of the performance spectrum for the past several years. After 10 years, Indian market has come into positive dollar return. Till three months ago, the dollar return was negative. Also, despite the late run-up, India finished CY20 with return of 12%, while Vietnam topped with 81%.”
Vietnam may have outrun India in terms of dollar return in 2020 but what makes the India run stand out is that it has come against the backdrop of dismal economic performance. While the stock market tends to discount the future, it had run up even pre-COVID on the same expectation, without any substantial revival in economic growth. For years now, analysts have continued to pencil in high estimates for Nifty companies, only to revise it lower (See: Lost decade). Sharma concurs but adds, “Brokerages have been forecasting 20% growth for the past six years but has that happened? P/E multiple has been elevated in most markets, because of extraordinarily low interest rate. That is artificially propping up multiples. When you adjust for the interest rate, the P/E doesn’t appear exorbitant.”
Samir Arora, founder, Helios Capital agrees. He says the FY21 forward P/E looks off the charts as “earnings have never been crushed this much, due to a one-off event. The market seems to have overestimated the length of the problem. That has now adjusted as for India, the market is now willing to accept high fiscal deficit.”
With businesses restarting post the lockdown, investors are banking on an economic recovery spurred by government spending. Neelesh Surana, CIO, Mirae Asset believes with respect to the economic recovery, there is more than the low-base effect at play. “We are going to see long overdue earnings from all sectors. It has happened in telecom after many years of competition and now banking is also coming out of the NPA situation,” he elaborates.
Where is the headroom?
Presuming the rally continues, where will investors flock to and more importantly, is there any ‘value’ left? Anoop Bhaskar, head of equities, IDFC Mutual Fund says, “This is not a ‘value’ market. Now, you have to hope that the companies you have bought deliver good earnings. While sector rotation is par for the course, pharma is expected to be fairly stable.”
Sharma likes auto stocks and thinks money will flow into banking and IT. He says, “Maruti has had a rough time for the past some years, so it has some headroom to rally, ditto for Tata Motors. I don’t see EV disruption playing out. Even if it gets 25% of the market, there is enough visibility for conventional cars.”
While Arora believes private banks and housing finance could be profitable plays, he is steering clear of the auto sector. “It’s not that EVs don’t matter in India. If coal as an investment doesn’t work in other markets, it won’t work here. Disruption doesn’t mean we will go to zero demand but which FII will buy a cyclical play in a down-trending industry?” he asks. Another sector that Arora prefers to watch from afar is the multiplex business. “Theatres are being disrupted. It is not the same as going to a restaurant. In the initial post-lockdown phase, theatres will be full. But after four movies, the general feeling will be, ‘We can watch it somewhere else’,” he remarks.
Even as the rally has gradually broadened, consumer stocks have not participated as wholeheartedly. Bhaskar attributes it to them already trading at high multiples. “These companies will see time correction rather than deep price correction as their earnings haven’t fallen. They have reported earnings growth between 15-19% and their stock price will fall only if there is earnings compression which has not happened.” Bhaskar also believes getting alpha from financial stocks at these levels will be very difficult unless one takes disproportionate risks with lower-rung banks. “You can’t make money now by allocating 10% of your portfolio to HDFC Bank and 9% to Kotak Bank,” he cautions.
In the current run up, India’s market cap to GDP ratio has reached 98% compared to the historical average of 75% (See: Higher than high). Investors certainly seem to be in a forgiving mood as far as India’s fiscal deficit is concerned but will the benevolence last? Already in the US, the 10-year yield hit 1.20% before tapering off to 1.10% and the perception seems to be building that the bond market is anticipating inflationary pressure in the latter part of the year.
Arora says while that might indeed be the case, the first few rate hikes do not puncture the market. “The period from 2003-2007, saw 16 interest rates hikes before the market corrected. The first few hikes would already get built in and the narrative would be about growth across all sectors,” he states. Sharma is ruling out rate hikes in India for now and says, “The risk is only inflation and interest rate. My view is that irrespective of inflation, interest rates will not be raised for at least one year, because the central bank will listen to what the government wants and if the government wants low rates, it will get low rates.”
What’s in store?
The current runaway rally has been entirely fuelled by foreign investors. Bhaskar says one factor that has been ignored is the unintended benefit that India got due to scrapping of the Ant Financial IPO. Post the scrapping, there was anxiety among foreign institutional investors about how much to allocate to China and some of it was diverted to India. “$350 billion had been committed for that IPO. If the Chinese don’t learn from this, emerging market money will flow disproportionately to India. If the Chinese figure out a way to soothe the frayed nerves of emerging market investors, then that money will reverse,” he explains.
Surana, though, expects foreign flows to continue in 2021. “Given the level of global interest rates, the fact that we are on a recovery cycle and that the rupee has not significantly depreciated, we should get $15 billion-20 billion on a yearly basis,” he says. Sharma, too, thinks 2021 will be good for emerging markets as they will benefit from the weakness of the US dollar. He adds, “The combined trade and budget deficit in the US is at an unprecedented high. It will put pressure on the dollar and you will see a move into non-dollar assets.”
The consensus trade is that the USD will weaken and emerging markets will benefit. However, if history is any guide, the opposite has also been true (See: Risk on risk off). Surana says as long as crude oil remains low and lower interest rates stay; the upward trajectory for the next three years is intact. “We have seen in the past that when the cycle turns, it doesn’t stop in one year and can extend for quite some period of time,” he mentions.
Arora is more worried about the vaccine trade unravelling as the assumption is that vaccination will be on time and by May things will be okay. But it is possible that the process may take 9-12 months or even longer. He clarifies, “In the US, vaccine usage is 20%. Even if they step up from current 3 million-4 million to 15 million-20 million, 2021 will be gone. So, the market can correct owing to disappointment.”
Then, of course, the favourite bogeyman around this time of the year is the Budget. While investors did not hold back their post-Budget disappointment over the past two, Arora feels this time around there isn’t much hype around the Budget. He points out, “Nobody is talking of Budget expectations. Yet, if one is tempted to call it ‘Great Budget’, there has to be something around personal taxes.”
For now, Arora does not see any reason to be overtly negative on Indian equities. “Though 5-8% fall can happen anytime, I am not too worried. The good thing about the rally is that Indian guys have redeemed. It’s not that everybody is buying, one group is selling,” reminds Arora.
Redemption pressure aside, domestic mutual funds continue to sell into the rally. Whether Indian fund managers will be proven prescient will be clear as 2021 unfolds. Surana says because the market has moved so fast from the March 2020 low, consolidation is long overdue. “I don’t see it more than 5-7% but our situation could get delicate if crude oil moves up. Hopefully, there is no adverse taxation in the Budget,” he trails off.