Structural bull-run in Indian stock market remains intact: Chris Wood

A ripple effect from the likely fallout of China's Evergrande and a possible change in stance by RBI are the two key risks for the market rally, says the global head of equity strategy at Jefferies

Even as local authorities in China rush to cushion the fall of Evergrande Group – their second largest property developer by sales – that can create a flutter across global financial markets, Christopher Wood, global head of equity strategy at Jefferies suggests that the structural bull-market in India remains intact. He has hiked stake in Bajaj Finance in his Asia ex-Japan long only portfolio by 1 percentage point (ppt). Wood had bought a stake in the company earlier this month.

“A broader based private sector-driven capital spending cycle, extending beyond the property sector, is now thought by Jefferies’ Indian office to be only a year away. A further positive is growing evidence of job generation. India also seems to be at a major inflection point in earnings, with corporate profits to gross domestic product (GDP) ratio bouncing off an all-time low of 1.2% in FY20 to an estimated 2.1% in FY21,” Wood wrote in GREED & fear – his weekly note to investors.

On Friday, the S&P BSE Sensex hit the 60,000 mark for the first time ever. The liquidity-driven rally has seen the index gain 25 per cent calendar year till date (CYTD). The rally in the mid-and small-caps has been sharper with both the respective indexes surging 42 per cent and 55 per cent during this period.

Analysts at Goldman Sachs expect capital flows to remain strong going ahead, given the robust IPO pipeline. “We estimate $12 billion of passive buying from the potential inclusion of unicorns in MSCI India over the next two-three years. Strong investor demand and ensuing capital flows could keep equity valuations high, support the rupee and further catalyze financialisation of household savings,” wrote analysts at Goldman Sachs led by Timothy Moe, their co-head of Asia macro research and chief Asia-Pacific equity strategist in a recent note.

Risks to the rally

Aside from the risk of another Covid wave, the major domestic risk to the Indian stock market, according to Wood, is a change in the Reserve Bank of India’s (RBI’s) dovish policy, which he believes will only be gradual.

While the central bank has been raising its inflation forecast in recent meetings, it has yet to signal a change in policy stance. The RBI increased its CPI inflation forecast for this fiscal year to 5.7 per cent in its policy meeting in August, up from 5.1 per cent projected in June. That apart, it had announced staggered increases in the quantum of funds to be taken out through variable rate reverse repos.

Ripple effect

Evergrande development, Wood said, will have a ripple effect on Wall Street-correlated world markets that have become used to bailouts.

“Evergrande’s acute liquidity crisis, signaled by the 86 per cent collapse in its share price since late February, has been almost inevitable ever since China launched its ‘three red lines’ policy in August 2020 asking selected property developers to conform to specific financial ratios,” Wood wrote.

The three red-lines are a set of thresholds on three financial ratios, Liabilities (ex-advanced proceeds) to Total Assets, Net Debt to Equity and Cash to Short-Term Debt, directed by the People's Bank of China (PBOC) and the Ministry of Housing in China that seek to cap developers' borrowings.

The real risk given Evergrande’s development, according to Wood, is if the responsible technocrats, who have been in charge of China’s extended deleveraging policy since 2016, of which the 'three red lines' policy is one manifestation, exit the scene.

“This would make GREED & fear nervous precisely because they have proved so competent in implementing the tricky balancing act of introducing market discipline into the system without blowing it up,” Wood said.