The stock market has been on a roller coaster all year. While in the short run markets mostly overreact both ways, over a sufficiently long period of time, if the economy is growing, the broad index rises above the inflation rate.
Investors who enter the market for the short run are usually speculators. Long-term investors never time the market, but there are times when even for them, the stage looks set for either a lump sum investment or padding up their existing systematic investment plans (SIPs). Market trends we analysed and experts we spoke to confirm that such a time may indeed be now.
The story so far
From the start of this year, foreign institutional investors (FIIs) were more optimistic about growth prospects in developed markets (much of their incremental investments got routed there) rather than emerging markets (EMs). FII net flow into India’s equity market for the first six months of 2011 was $0.6 billion (Rs2,670 crore) as compared with $4.66 billion for the same period in 2010.
Says Toral Munshi, head, India equity research, wealth management, Credit Suisse (Securities) India Pvt. Ltd, “Fund flows in the first half of 2011 indicate a bias towards developed markets. At $29 billion in 2010, India received record inflows, almost a third share of total EM flows that year, quite disproportionate to India’s relative weight in EM portfolios. Therefore, flows were bound to slow down in early 2011. Then there were high commodity prices and policy lethargy.”
On the home front, inflation stood out stubbornly, coercing the Reserve Bank of India (RBI) to continue increasing policy rates. The impact of a series of hikes can be seen on the gross domestic product (GDP) growth rate at various levels. The May 2011 numbers for the Index of Industrial Production (IIP) report industrial growth at 5.6% as compared with 8.5% in May 2010 and 7.5% in January 2011. RBI data for scheduled commercial banks shows that credit growth has slowed from 23.32% in January 2011 to 21.78% in May 2011 (provisional figures).
Adding pressure were external factors such as the ongoing European debt crises and high commodity prices, which kept investor appetite for equity and risk subdued. All these factors collectively contributed to the 8.16% decline in the Nifty 50 index since January 2011.
The way forward
Interest rates: At present, the biggest overhang on domestic equity markets is persistent inflation and the resultant interest rate tightening. The jury is out on where inflation is likely to settle. However, the expectation for further rate hikes is low as impact of the previous hikes is being felt now. Says Prateek Agarwal, chief investment officer, ASK Investment Managers Pvt. Ltd, “There could be another 25-50 basis points hike in rates in the next six months. Nobody is talking about a further increase.”
According to Munshi, there may be a pause in the rate hike cycle in the second half of this year, given the moderation in macroeconomic data.
Earnings growth and valuation: Expectations on earnings growth remain muted for the first quarter of FY12, but valuations look better. According to a Kotak Securities Ltd report, for the June quarter, expected earnings growth for 30 Sensex companies is 9.5% year-on-year (y-o-y). An Angel Broking Ltd report on the result preview for the first quarter expects net profit growth of 14% y-o-y for Sensex companies for the same period. This earnings uncertainty is most likely already priced into the markets. Says Agarwal, “Growth could worsen, leading markets lower in the near future. But the outlook for FY13 is positive and in the range of at least 20%; this will start getting priced in in the next 6-12 months.”
The Angel report also estimates a compounded annual growth rate of 18.4% in Sensex earnings over FY11-13; this roughly values it at an estimated price-earnings (P-E) multiple of below 14 in FY13 compared with a historical average of around 17 one-year forward P-E. Given the level of earnings growth expectations in the next two years, it is reasonable to say that although the equity market today is not cheap, it’s fairly valued.
Fund flows: FII flows can remain sporadic and difficult to predict. However, considering the recent correction in the domestic market and the hurdles in global growth, the relative growth and valuation of Indian equity markets look better. Agarwal says, “Last December, valuations were high and global macro factors looked positive. Now India valuations have corrected and global macro has worsened; hence, positioning of Indian markets has improved.”
He adds that other countries may undertake tightening measures now when India has almost completed its tightening. This could renew foreign investor interest in India. So far in July, FIIs have made net investments of $1.54 billion, at least double the net amount invested in the first six months.
Typically, short-term FII flows are volatile but over a longer period these ups and downs get evened out. Says Vishal Kapoor, head of wealth management, Standard Chartered Bank, India, “In the short term, FII outflows reflect flight to safety and have a big bearing on the market, but over a period of time even FIIs go after growth. India’s fundamental growth story is on track and FIIs will remain invested.”
What does all this mean?
The fundamental outlook for India is intact. Even though GDP growth has slowed from 9.3% in the first quarter of FY11 to 7.8% in the last quarter; but this is relatively better than other economies. According to a recent release from Credit Suisse, Indian GDP is estimated to grow by 8.5% and 8.7% in 2011 and 2012, respectively. Compare this with FY11 global growth forecast of 4.3% and 7.3% for EM-8 (EM-8: Brazil, China, India, Indonesia, South Korea, Mexico, Turkey and South Africa).
Also, equity valuations have corrected and look relatively better. For example, although the Sensex has corrected 3.55% from April till date, the Sensex earnings in the June quarter are expected to grow by 9.5%, according to consensus estimates compiled by Bloomberg.
With fair valuations, expectations of a pause in rate hikes and a lot of negative news priced in, further downside in markets seems limited. Notwithstanding the risks in the market, there is a strong case to be made for a rally in equity markets towards the year-end given the above considerations.
What should you do?
Continue your SIPs and systematic transfer plans (STPs), which are not only a good way to invest for the long term but also help manage short-term volatility. As an investor use meaningful dips of at least 7-10% or more in the market to pad up your existing SIPs.
Given the correction so far this year, the equity portion in most portfolios is likely to be below the target allocation. This is a good time to bring that to the original level. The key is to invest in small portions spreading your purchases over the next six-eight months rather than in one go. Says Kapoor, “This is a good time to rebalance equity allocations. Fundamentals are on track and valuations are fair, investors can use SIPs and STPs to increase allocation.”
You must also keep in mind that whether or not equities are priced attractively, risks remain in the market. Says Gaurang Shah, assistant vice-president, Geojit BNP Paribas Financial Services Ltd, “Earnings growth is a major driver for markets and it’s in an uncertain zone and needs to be watched for some time.” The other big risk today is government policy action. Many a times risks play out more severely than we expect them to. If that happens, you should reassess the fundamentals and space out your investments over a longer time period of correction or market volatility.