Love for Indian equities will only grow: Expert

Huge and concentrated disruptions-demonetisation, GST, RERA; while evidently painful in near term-should accelerate this seminal transition

India is, the last week notwithstanding, a much-loved market. It’s got performance (up 19 per cent year-to-date), potential (7-9 per cent GDP growth) and popularity. That said, its got pushbacks too—high valuations, and more recently, faltering growth. We argue the love for Indian equities will only grow and its valuations will stay high (16-20 times band) over the next three years—as big fundamental transitions play through and pent-up cyclical drivers kick in. It has its challenges—near term growth, job creation and modest investments, but upsides trample some of what is coming its way. 

A fundamental transition. . . 

We see fundamental transitions at play, that are  changing India’s dynamic; a) supply-side flexibility offering a longer runway for growth, with lower inflation risks; b) reform and government cycle: a lot of hard work has been done, the gains lie ahead – and the government seems well positioned for another term; c) equity flow shift: there is a domestic deluge; there might be temporal factors at play currently, the savings pot has been stirred, and domestic inflows to equities should go a long way; d) digitisation of the economy; a J curve ahead on efficiencies; e) energy: cost and availability dynamic has changed; and f) corporate focus: profitability/M&A and shareholder value. The huge and concentrated disruptions—demonetisation, GST, RERA (Real Estate Regulatory Authority); while evidently painful in the near term—should only accelerate this seminal transition. The transitions will show up in parts, but their sum will create a faster, more efficient and profitable economy.  

 . . . with cyclicals lining up

Disappointments lie in its cyclical drivers—weak for long and yet to turn. They remain hard to accurately time, and could falter further, but between: a) Earnings: likely bottomed, looking at 14-15 per cent two-year compounded annual growth rate, relatively broad-based; b) Asset quality cycle: recognition and reasonable provisioning now in, forced resolutions on; gains on the horizon; c) Capex cycle: government spend backed so far, likely to see only a modest pick-up; d) Interest rates: Down, likely to fall—India’s  cyclical drivers are coiling up, readying to collectively spring back. While the cyclical elements have so far been disappointing – and remain relatively hard to time or call, India is getting closer to a collective bounce-back. A disruption heavy base (demonetisation, RERA, GST) could add to the rebound.

Drags rather than big risks

There are market drags and risks—challenges on agriculture (structural and cyclical), lack of job creation, loan waivers (risks to credit culture), too much equity paper and risk on the rupee rise and possibly even over-optimism. These clearly are challenges, but they are more drags on markets, than fundamental or new risks.

India will trade expensive 

The overvaluation argument is an easy one. But, fundamental transitions and lining-up cyclical drivers will raise the valuation framework till the cyclical gains actually play through. That could be in the next three years and the market is likely to trade at a 0-25 per cent premium to average PE multiple of 16-20x. Valuations will revert to the mean, but only once growth and return on equity settles higher, and interest rates settle lower. Till then, India will trade high – and should give equity investors reasons to be optimistic, and expect decent returns. 

The author is Head-Research, Institutional Equities, Edelweiss Securities