The Indian stock market is not in a new bull phase. Currently, the Nifty seems to be in a big trading range of approximately 4,500 to 6,000. As the market is in the lower half of this range, a decent upside is possible—which we think can happen in the coming months. However, the market is not breaking new levels. So what does it indicate?
Our framework suggests that there are three fundamental ingredients to a bull market—bullish steepening of the yield curve, expanding profit margins and attractive valuations.
The yield curve tells us what the bond market thinks about growth and, thus, it influences performance of equity markets. Bullish steepening (short-term rates are falling faster than long-term rates) should set the stage for economic recovery.
Profit margins are the interplay of the investment and consumption rates in the economy. If better policy action backs this, the investment rate will pick up. And as profits rise, so do share prices, and then higher share prices feed into profits.
Valuations only matter at extreme levels. Currently, valuations either are in the bottom decile or close to them. This augurs well for equity returns.
Ownership, sentiment and liquidity are also important, and, to that extent, trailing performance as a reliable measure of sentiment and ownership and our modified earnings yield gap approach to assessing the amount of liquidity needed to push share prices higher complete the virtuous circle that drive bull markets in equities.
View: Valuations are attractive and almost ready for a new bull market. The yield curve is laying the groundwork, whereas the worst for liquidity is behind us—or so it seems from our assessment. Profit growth is entering a period of mild recovery, but we do not believe a full-blown margin expansion cycle is on hand. Sentiment seems to be as bad as at bear market troughs. We believe that the market is preparing for the next big bull market, though we are not quite there yet. Investors can continue to make outsized returns as individual stocks, large and small, are already in a bull market.
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Edited excerpts from a report by Morgan Stanley. Comments at firstname.lastname@example.org