BackFrom Thatcher to Reagan, how markets reward reforms
All it would need for the rally to get a second wind is an announcement by new government of a road map for reforms
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Voices of caution are being raised about the rally in the equity markets. In a 22 May note, Deutsche Bank AG strategists John-Paul Smith, Priyal Mulji and Punyadeep Cheema say the Indian market is taking too much for granted and reforms are not going to be easy. It’s interesting that the tone of the report is markedly more downbeat than an earlier Deutsche Bank note of 16 May, in which the bank’s India research team not only forecast a Sensex target of 28,000 points by December, but also wrote, “The Indian market tends to give a new government the benefit of hope and hence we strongly believe that the market is unlikely to consolidate meaningfully until the budget."
There are many other voices advising prudence. A recent note by Goldman Sachs says, “With the degree of optimism now invested in the incoming government, the bar for positive surprises to be priced into Indian equities has been raised significantly." A Citigroup note says, “The sprint may have run its course in the short term." The key argument being made is the market’s premium to other emerging markets is now very high.
But the 22 May Deutsche Bank note also makes an interesting reference to the impact of Margaret Thatcher’s election as British prime minister in May 1979. It points out that the UK markets were 20% lower by November 1979, having, like the Indian markets, run up in anticipation of Thatcher’s win. It also points to the same sort of performance by other countries recently going in for structural reforms, such as Mexico and China. Their performance has been “a circa +30% YTD (year-to-date) rally in front of the election followed by a sell-off of around minus 20% over the subsequent six months."
Let’s start with Thatcher. The FTSE All-Share index went up around 27% from its close in December 1978 to the end of April 1979. Thatcher was elected in May 1979. After that, the All-Share index lost around 17% till end-December. By the end of 1980, though, the index had gained 27% from its December 1979 close. That was despite a recession that year as the government clamped down on inflation. So it would have made sense, with the 20:20 vision of hindsight, to sell after the election and re-enter the markets six months later. Most investors, though, are notoriously bad at timing exits and entries. So perhaps the question to be asked is: what returns did Thatcher give over the long haul? According to data from Fidelity, the UK stock market gave annual returns of 11.79% between her election in 1979 and her giving up office in November 1990, one of the best returns under any British prime minister.
How did Ronald Reagan, the other great initiator of supply-side reforms, fare in the stock markets? He won the November 1980 elections, but it wasn’t until December 1982 that the S&P 500 index closed at a level higher than that of November 1980. It was because of US Federal Reserve chairman Paul Volcker’s bitter anti-inflationary medicine, which led to a recession in the first two years of his presidency. On 12 August 1982, the Dow closed at a low of just 776.92 points. Before the end of that year, the index had surged past 1,000, and by 1987 it peaked at 2,722.42. The crash in 1987 brought that bull run to a halt, but it can well be argued that Reagan put in place the reforms that led to the huge bull market in the 1990s in the US.
But let’s take a far more recent example, that of the Philippines. In local currency terms, the MSCI Philippines equity index is up more than India’s, year-to-date. Rating agency Standard and Poor’s (S&P) upgraded the country’s sovereign rating recently to one notch above investment grade, a year after it was elevated to investment grade. S&P raised the rating because it thinks, “The ongoing reforms to address shortcomings in structural, administrative, institutional, and governance areas will endure beyond the current administration." According to the World Bank’s Ease of Doing Business reports, the Philippines improved its rank from 146 in 2010 to 108 in 2014. Over the same period, India’s rank improved marginally from 135 to 134. China’s slipped from 78 to 96.
The reform measures and the consequent improvement in the Philippines’ credit rating has led to gross domestic product growth rates well above India’s in the last two years and an annual return of 19.8% in MSCI Philippines in the last five years. MSCI India’s return, after the current rally, has been 11.1% per annum in the last five years.
It is true that valuations for the Indian market have gone up sharply in the last few weeks. Foreign institutional investor flows, too, have slowed and economists are pointing to the long hard slog ahead for the recovery. India is already the favourite market among global emerging market investors, according to the latest Bank of America Merrill Lynch survey of fund managers. Even so, according to a 19 May report by Macquarie Research, while the one-year estimated price-to-earnings (P-E) multiple was 15.3 on that date for MSCI India for earnings per share (EPS) growth of 14.8% and return on equity (RoE) of 15.7%, the P-E multiple for MSCI Philippines was 18.9 with EPS growth of 10.3% and RoE of 14.4%. All it would need for the rally to get a second wind is an announcement by the new government of a road map for reforms, together with some immediate steps towards unblocking stalled projects, reversing some of the controversial tax decisions and easing some business regulations.
Manas Chakravarty looks at trends and issues in the financial markets. Your comments are welcome at capitalaccount@livemint.com.
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