Equity outlook: Rally is likely to continue

Growing expectation that the country will have a stable government (read Narendra Modi-led) has led to momentum continuing to drive the markets higher. From a low of 6,001 on February 1, the Nifty is nearly 13 per cent higher in only 56 trading sessions. The indices are recording new highs on a near-daily basis, and after a long time, India is again a sweet spot for global investors.

Foreign institutional investors (FIIs) have pumped nearly $4 billion in the first quarter of 2014. Inflows in the previous five years have been much higher than the capital received in the five years preceding that, which was, in fact, a bull market.

On the whole, investors are more positive on India than they were in the previous few months. The reason cited by most is that India continues to be relatively a better place than most of the other emerging markets, especially the large ones such as China, Brazil, Russia, Turkey. These markets have structural problems. Whereas, India has a cyclical problem, which, the market perceives, will get addressed after elections, when we have a stable government. Also, the macros are looking much better than some months ago.

However, a majority of domestic investors are sceptical about this rally and term it nothing but "money chasing momentum". They argue the markets are getting ahead of themselves, and there is no certainty Modi will become the next prime minister. And, even if that happens, he has no magic wand to turn things around in the near future.

The arguments are many: Fiscal problems remain, public sector banks, which constitute a large portion of the banking system, need huge equity themselves and, therefore have no strength to fund India's growth. The government does not have the money, clearance of the goods and services tax and the direct taxes code will not be easy unless a government has a clear majority. Inflation is not going to go away in a hurry and high interest rates are likely to stay for some time, keeping growth muted for many quarters. Also, they claim the market has already priced in as many as 225 seats for the National Democratic Alliance and, therefore, this Modi-rally is largely discounted for.

However, this rally could grow in strength. While volatility after the election results is possible, the fact remains that the Nifty highs are not corrected for the rise in inflation or the fall of the rupee. Thus corrected, the Indian markets are still around 30 per cent below the highs it scaled in January of 2008.

In terms of valuation, we are ruling at 14 times the 2014-15 earnings. Though this looks relatively higher compared to other emerging markets (nearly 35 per cent higher), it is still far from being termed expensive (long-term average is 15 times). Also, most important, India is far closer to the end of the growth slowdown.

Of course, we are not going to see a sharp improvement in gross domestic product growth for quite some time. However, the market perceives that with better governance and faster decision-making, somewhere, the investment cycle will start all over again and growth re-emerge. It is this positive direction (of growth picking up slowly) that should keep the markets looking for more.

The author is principal and head, private client group, Nirmal Bang Securities