The rally in April and early May lifted hopes for a repeat of the long, deep rally that began a decade ago. An optimist could discern similarities between 2003 and 2013. Economic growth may again be bottoming out, inflation may be in retreat, savings may be poised to return to equity and valuations are well below their peaks. So, could the optimist be overlooking the risks and getting carried away by a few positive developments?
But 2013 has a few differences with 2003. Back then, India had a relatively stable coalition government with a pro-reform tilt. Macro-economic indicators were broadly stable with a positive tilt. Foreign capital inflows zoomed up as the share of global foreign institutional investor (FII) inflows to India exceeded its weight in the emerging market indices. The rally of 2003-07 moved India from the periphery to the mainstream within the emerging markets (EMs).
With gross domestic product (GDP) nearing $2 trillion and, with nominal GDP growth of around 10 per cent, India is unlikely to be ignored by global portfolio managers. India's share within global FII flows stayed in double-digits even during the bad spells in the past five years. Interestingly, FIIs sold less in India in two recent years, when they sold equities across the world, compared with sales in other EMs. This may partly be explained by the lower liquidity of Indian equities and by foreign investors' willingness to have a longer-term perspective. They also may adopt a less critical attitude towards the weaknesses in the India story. Some investors may be less worried by the rising corruption; the bigger concern seems to be the obstacles posed by poor infrastructure to GDP growth.
Early signs suggest the mutual fund industry is nearing another wave of inflows into equity products. The intense selling of 2012 is now over. The past three months saw either a marginal outflow from equity products or an inflow. With the market value of aggregate equity assets under management having risen above cost, the urge to sell among retail investors is ebbing. If the yields on income funds were to dip, the pull towards equity products could strengthen, as it did in 2004-06. A revival in the equity mutual fund industry would support a higher valuation for equities, particularly if India's share in global FII flows stays stable.
Year 2013 is likely to see a combination of forces that are capable of lifting equity valuations. Together, a modest revival in GDP growth and corporate profits, an improved policy regime, gentle decline in the twin deficits, inflation and interest rates, combined with renewed appetite for equities among local investors could extend the current rally. The uncertainties around these factors may also raise the volatility of stock prices, but the prospect of higher returns may prevail over the risks.
The writer is executive director, head of research, Avendus Securities
But 2013 has a few differences with 2003. Back then, India had a relatively stable coalition government with a pro-reform tilt. Macro-economic indicators were broadly stable with a positive tilt. Foreign capital inflows zoomed up as the share of global foreign institutional investor (FII) inflows to India exceeded its weight in the emerging market indices. The rally of 2003-07 moved India from the periphery to the mainstream within the emerging markets (EMs).
With gross domestic product (GDP) nearing $2 trillion and, with nominal GDP growth of around 10 per cent, India is unlikely to be ignored by global portfolio managers. India's share within global FII flows stayed in double-digits even during the bad spells in the past five years. Interestingly, FIIs sold less in India in two recent years, when they sold equities across the world, compared with sales in other EMs. This may partly be explained by the lower liquidity of Indian equities and by foreign investors' willingness to have a longer-term perspective. They also may adopt a less critical attitude towards the weaknesses in the India story. Some investors may be less worried by the rising corruption; the bigger concern seems to be the obstacles posed by poor infrastructure to GDP growth.
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Unlike 2003, the level of FII activity is not low and it is unlikely to get better. Thus, the medium-term drivers of equity valuation need to be an improvement in corporate earnings, rise in flow of domestic savings toward equities and improved confidence in the policy makers' ability to return to the path of higher GDP growth. Two striking examples of the latter are the cut in the repo rate by RBI despite the high degree of caution on the macro-economic conditions and the hike in diesel prices despite the ongoing political crisis. Earnings growth has stayed in single digits for two years but the forecasts that point to about six per cent real GDP growth for FY14 raise the likelihood of a return to double-digit growth.
Early signs suggest the mutual fund industry is nearing another wave of inflows into equity products. The intense selling of 2012 is now over. The past three months saw either a marginal outflow from equity products or an inflow. With the market value of aggregate equity assets under management having risen above cost, the urge to sell among retail investors is ebbing. If the yields on income funds were to dip, the pull towards equity products could strengthen, as it did in 2004-06. A revival in the equity mutual fund industry would support a higher valuation for equities, particularly if India's share in global FII flows stays stable.
Year 2013 is likely to see a combination of forces that are capable of lifting equity valuations. Together, a modest revival in GDP growth and corporate profits, an improved policy regime, gentle decline in the twin deficits, inflation and interest rates, combined with renewed appetite for equities among local investors could extend the current rally. The uncertainties around these factors may also raise the volatility of stock prices, but the prospect of higher returns may prevail over the risks.
The writer is executive director, head of research, Avendus Securities