Indian equity markets have delivered around 15 per cent returns in the year-to-date and are among the best performing asset classes domestically. The question is about the future outlook. The overall valuations in the market are significantly lower than average valuations and hence the market still may offer significant upsides to a fresh entrant. Several of the worries that plagued the market during the end of last calendar year have either been addressed, have been pushed to a later point in time, or reconciled with and portfolios positioned accordingly. Given the fact that the portfolios are now largely positioned in the capital efficient businesses, businesses throwing up free cash flows, export-oriented businesses with pricing power and businesses not influenced by policy making, the bad news is no longer making a dent that it otherwise should have. We have seen the market inching up while inflation has refused to go down, growth has slowed down, there is a threat of monsoon failure and RBI has refused to cut interest rates. While the upmove has clearly been supported by the global ‘risk on’ trade, given the fact that India is one of the better performing markets, it also partly reflects the under-valuation and under-ownership.
We continue to believe that a large part of the market offers value at this point. A portfolio of best performing stocks in the market has delivered returns in line with the growth in earnings over the past five-year period. Hence, even the performing part of the market has, at best, sustained valuations. This part of the market should be expected to deliver performance in line with earnings growth, going forward. The part of the market that has got battered down (like the power sector) holds the promise of performance if certain policy measures are taken. While we are focused on reforms on resource allocation, we would wait for reforms to happen, rather than position the portfolio in anticipation of these reforms.
Given the fact that valuations are benign, we are hopeful that equity valuations would sustain and may improve. Policy making towards equities is becoming more favourable. Steps have been taken to channelise the savings of small towns into equity markets. Contentious issues like GAAR have been postponed to a later date. Moreover, there has been talk of reviving the animal spirits of corporate India. At this juncture when debt funds are hard to come by and expensive and corporate sector balance sheets are highly leveraged, clearly it can happen only after equity markets revive and it becomes possible for corporates to raise equity. However, we have a long way to go in terms of market levels, because at current valuations we are witnessing more of buybacks rather than fresh equity issuances.
As said before, capital-efficient businesses are likely to perform well and upside can be there in sectors like pharmaceuticals and IT. Segmenting the market on ownership pattern, MNC businesses could offer significant upside. These businesses are very capital efficient, have access to technologies and brands and have shown increased commitment to Indian opportunity over the past few years. Our studies have shown that an equi-weighted portfolio of MNC businesses has beaten the benchmark indices over the last twenty years over any period of rolling five years. Even during the last 10 years, this pack has beaten the index in eight of the years. We believe this part of the market may offer a good way of taking an exposure to the equity market over the foreseeable future.
The author is CIO, ASK Investment Managers Pvt Ltd
