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Many market players have been surprised by the recent sharp run-up in the markets taking the Nifty to a new all-time high
level. Not only that, the Indian markets have outperformed most global markets year-to-date having improved by over
three per cent compared to losses running of four-10 per cent for most of the emerging markets.
Most onlookers have dubbed this uptrend a ‘hope’ rally i.e., the markets are hoping the elections will result in a stable and progressive political scenario.
However, a closer analysis reveals that there are more fundamental reasons:
(a) Governments policy actions over the past 12-18 months have partly rectified the earlier policy inertia . Macro economic
fundamentals have reasonably improved over the past few months. These include a significant narrowing of the current account deficit — leading to a more stable currency; moderate improvement in the fiscal deficit and tentative indications that inflation could be peaking.
Moreover, the government has cleared stuck projects of about ~5,00,000 crore; thereby raising hopes that the investment cycle will revive over the next few months.
(b) In any market, valuations have to be supportive for a sustained market upmove. Six years of ranged markets have
resulted in fundamentals (earnings) catching up with valuations. Consequently, at an expected FY15 earnings
per share of just under 500 for the Nifty, the Index trades at only a 12 times multiple at a Nifty level of 6,000. The
average secular price earnings (PE) multiple has been in the range of 14 times. Thus, there is ample scope for improvement in stock prices. It must be mentioned here that experience shows that cheap valuations are a predominant factor in any sustained up-move.
It is therefore not inconceivable for the Nifty to touch a level of 7,500, provided the election results are positive; at that level, it would trade at 15 times forward earnings, which by itself is not extraordinarily expensive.
However, this is not to say that all is hunky dory. There is, of course, the danger of inconclusive election results which
would lead to extreme market volatility and uncertainty. Even with positive results, there could be other impediments
to the progress of the uptrend. The new government would need to implement economic policies which will not only
start the investment cycle, but also rectify some of the pre-poll excesses resulting from a new Pay Commission, a 50 per cent increase in the rural job guarantee investments and ballooning food subsidies which would threaten fiscal stability in
the event of unfavourable monsoons. There are also more structural issues resulting from the new land acquisition
law which will sharply push up projects costs.
There are also early indications of a developing El Niño event which could threaten normal rains in the coming monsoon season. This would not only impede economic recovery but also dash hopes of lower inflation and interest rates.
This would be pity as after a gap of several years, real interest rates have started turning positive, which augurs well for
economic and investment activity.
Thus, I am hopeful the markets, having broken out of a six-year trading range, are now set to enter a long bull market.
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The author is group chief investment officer, IL&FS Group
