There has been some incremental improvement in the economic situation since the previous Diwali. The economy continues to cruise at a growth rate of close to 7.5 per cent of gross domestic product (GDP). Corporate earnings growth rates have also remained on even keel.
But, sentiment — “hawa” — has improved. The celebrations of Diwali 2015 were muted due to two successive years of drought. Food inflation was high and nobody had cash to spare. This year, things should be better on several counts. The monsoon was decent and the Seventh Pay Commission is putting money into the pockets of government employees and pensioners. A fair monsoon has reduced food inflation and boosted rural sentiment. Pay Commission hikes should help boost personal consumption.
Personal consumption will be the main driver for growth. Vehicle sales have picked up in the past few months. The July-September results indicate that housing mortgage volumes have improved. Competition between online portals has led to items of personal consumption like apparel, shoes, consumer electronics, home furnishings etc, being marketed with massive discounts on offer.
There is also a wealth effect emanating from gains on the stock market. Retail (small) investors have increased their exposure to the market in the last year, both directly as well as via mutual funds. Since domestic institutions and foreign portfolio investors have also been net buyers, there have been capital gains in many sectors.
The contrasting performance of small, mid-sized and large stocks indicates retail influence. The BSE small-cap is up 20 per cent in the last year while the NSE 500 is up 9.5 per cent. There is relative underperformance in the giant stocks of the Sensex (up 5.9 per cent) and Nifty (up 3.4 per cent). Only retail investors buy small-caps with sufficient enthusiasm to drive prices up in this lopsided fashion.
However, the really big gains have come from the mid-to-large caps. The Nifty next 50 (previously called the Nifty Junior) is up an amazing 29 per cent year-on-year. In terms of size, the next 50 stocks are large and liquid enough to satisfy institutions, while also attracting retail interest.
Between October 2015 and September 30, 2016 (the last date for which we have data), fund assets under management (AUM) increased by 20 per cent to Rs 15.8 lakh crore from Rs 1.3 lakh crore (September 30, 2015) The AUM of equity funds rose by 17-18 per cent, while balanced funds saw a 50 per cent increase in AUM, albeit from a smaller base.
However, income funds saw a 23 per cent increase in AUM and the asset allocation across categories did not change. Investors continued to park 44 per cent of total AUM in income schemes, with about 27 per cent going into equity schemes and another four per cent into balanced funds. The liquid/money market fund segment also attracts about 20 per cent of AUM but that is almost entirely institutional.
The income fund investor should be happy, going into the next Samvat, given the trend of rate cuts and falling inflation. This means capital gains for income funds. Equity fund investors should also be happy, since most funds have given positive returns and many have beaten their benchmarks.
The fixed income investor should receive windfall gains from debt funds if inflation trends down and rate cuts follow from the new Monetary Policy Committee. However, many households will be unhappy since bank fixed deposit rates are also dropping and the average household has a higher proportion of savings in FDs than in debt funds. Most analysts also think that earnings growth will accelerate. Hopes that the goods and services tax will finally come through has energised institutional investors.
Asset allocations should not change too much in the circumstances, since both income funds and equity are expected to continue to do well. Equity valuations are a cause for some concern, since index valuations have hit historically unsustainable levels. Equity investors will also have to live with the inevitable political risks of key state elections in 2017 and an increasing focus on politics until the general election of 2019.
On the other hand, the economy has serious upside potential. In cyclical terms, the business cycle has barely started picking up and there is room for earnings acceleration across multiple sectors. Liquidity remains good and will in fact, improve, since the monetary policy is inclined that way. Taken together, this could be enough to sustain valuations and shrewd stock-pickers might have a field day.
Happy investing!
