BackEquity may beat fixed income in the medium term
A correction can’t be ruled out but it will be short-lived and give a buying opportunity
PremiumThe equity indices have rallied worldwide since the bottom which formed in the last week of March. Indian indices have done better compared with global indices in this period (March to October 2020). For example, between 23 March (when the markets bottomed) and 27 October, the Nifty 50 TRI was up nearly 58%, while the MSCI EM (USD) index was up just over 52%. What explains this performance, when the GDP shrank nearly 24% in the first quarter of FY21, and is expected to shrink for the rest of the year, though at a much slower pace.
While a substantial part of the rally, especially in the initial months, may be explained by the attractive relative valuations for India versus other markets and the easy liquidity conditions engendered by the actions of global central banks, there are other factors which have led to the markets holding on to their gains and gradually moving up.
The recovery in the physical parameters and consumer demand in the economy has been sharper than was being projected a quarter back, as the economy began reopening after the lockdown. Physical parameters like railway freight, electricity consumption, e-way bills, television ads, GST collections, exports, diesel demand (up year-on-year in the first half of October), among others, have shown smart recovery.
Consumer demand is showing signs of recovery for passenger vehicles, for a wide range of consumer durables, and for home loans. Low interest rates, increasing affordability, and stamp duty reduction by select state governments like Maharashtra has led to a sharp increase in home buying. Finally, on the demand side, the rural economy has been a very big support. The last two crops have been good. The forthcoming rabi crop is also expected to be good in most parts of the country. This has supported demand for tractors, agrochemicals and fertilizers. Another positive factor has been the corporate sector reaction to the pandemic and the lockdown. While most good companies had strong balance sheets going into the pandemic as they had cut down on debt, they have further rationalized costs and preserved cash during the pandemic. While some of these costs relating to travel, on employees, or ad spends will come back, we expect around 30% of the cost cuts will sustain at least for the next few years.
The positive performance from corporates combined with low expectations has led to earnings upgrades. September was the first month which saw earnings upgrades for the BSE 100 for FY22, according to Credit Suisse data.
It is also notable that the pandemic has in a sense led to more polarization in the performance of companies. Larger companies from the organized sector with recognized brand names have gained as smaller companies had issues with funds and working capital. Further, the shift from unbranded to branded products has accelerated as consumers preferred the safety of well-known brands in the pandemic. In addition, the competitive intensity across sectors is likely to reduce with pricing power returning to most of the established companies. Some of these gains will sustain and the set of well-run companies with moderate debt will come out ahead as a result.
A long-term positive for the economy is the government’s thrust on supporting domestic manufacturing. While it is early days yet, we think that if the government consistently sticks to the policy and executes well then India can certainly attract manufacturing facilities led by the large domestic market, competitive tax rates, and lowered barriers to doing business. If it works well, this will create a meaningful number of jobs and result in income generation which may boost consumption.
Overall, the market has had a sharp run-up in the last seven months, and a correction cannot be ruled out after the strong rally. However, we believe that any correction will be short-lived and will be a buying opportunity. Equity is very likely to be a relative outperformer compared to fixed-income over the medium term (three to five years). This will be backed by valuations, which while not cheap are not too expensive, and the improving efficiency of the corporate sector which will likely see improving return ratios going forward. We expect sectors like chemicals, consumer discretionary, telecom, IT, large cap financials, cement and healthcare to do well. But verify your investments.
Rajat Jain is chief investment officer at Principal Asset Management
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