Equity Outlook: Cycle waiting to turn for the better

May is the season of corporate results but all eyes are on the election results and the subsequent direction the market is assumed to take. Since it is already a well-known and well-discussed topic, let me try and make a case for the direction based on the fundamentals and what could change, rather than the election outcome and its impact.

As of now, the average valuations of the market, at about 15 times the earnings of 2014-15, are below the long-term averages and there are strong prospects of growth picking up, driven by the following factors:

1. Restart of mining activities in Karnataka, Goa and Odisha. This is now a matter of time, with the Supreme Court laying out the road map for the resumption. Metal companies that depend on these mines for ores would restart production and add to growth. This is the low-hanging fruit. Capital assets are underutilised. We would get growth as the utilisation improves.

2. Redirecting subsidies towards building national infrastructure. Thus, jobs would be created and durable assets can be built, unlike the current distributive model, which fuels consumption through subsidies.

3. Revival of confidence and restart of private sector capital expenditure. As confidence returns, private sectors would start spending on capacity enhancement again, which would accelerate growth.

4. Reduction of subsidies would improve government finances, improve inflation, release capital from the banking system and force banks to find new borrowers, thereby, bringing down lending rates, which would be growth-positive.

5. Slowdown in China leading to downward pressure on commodity prices and currency movement over the last few years has increased the competitiveness of the Indian manufacturing sector.

6. Global growth, which was proving to be a headwind, is now providing tailwinds.

Moreover, the valuations in the market are no longer driven by a few sectors. Over the past few months, beaten- down sectors, such as public sector banks, capital goods and construction companies have seen valuations improve, while the premium sectors have seen a correction, making the market healthier.

Given the positive outlook on growth over the next few years and lower than average valuations in the market, we believe the buoyancy in the stock markets would continue, except for the worst possible outcome of a fractured mandate.

There are headwinds, for sure. US taper is increasing their short-term rates and this would put pressure on Indian rates to continue to stay high. Also, the current rally in India is a confluence of factors. India has witnessed higher flows in anticipation of a political change and also because flows into China, Brazil and Russia have declined. These inflows into India, however, might not last long.

India, however, has seen a sharp current account deficit correction and is now much better positioned for continued US tapering. The currency is stable and foreign exchange reserves have shown improvement.

Over the past three years, the market focused on quality of business and this set has done very well. We believe as economic growth returns and policies become business-friendly, growth would be the focus of the markets. Quality companies, which have the potential to grow fast, would tend to outperform. While large-cap indices are at a high, the mid-cap indices are still significantly below earlier peaks. We believe quality mid-caps, which would benefit from sharper growth acceleration and present acceptable valuations, could capture the imagination of the market.

The author is chief investment officer, ASK Investment Managers