Increase Your Investments In Growth Companies

The markets have recently been gyrating to the happy preliminary forecast of a favourable monsoon and, by all appearances, such forecasts may turn “heavy with clouds” in the next eight to ten weeks. And stocks are losing no time in recovering lost ground. They are making up for the losses suffered in the early months of 2015. Over the last two months equity prices have perked up about 12 per cent. Now stocks are just about 13 per cent short of their all-time highs of last March, emerging a long way from the depths of the 20 per cent losses scrapped in February 2016.

If such a deluge of good news continues, experts point out Indian markets could end 2016 on a new high. The Indian economy is not yet fully off the ground. Markets, however, are not looking back; they are looking ahead. “Markets are a leading indicator; the economy is a laggard,” says Ajay Bodke, CEO and chief portfolio manager, PMS Services, Prabhudas Lilladher. “If one waits for signs of a full-fledged recovery, the markets would not be where they are today,” he continues.

Clearly, it’s the news about the monsoon that seems to have added more spring and legs to the market. Budget 2016 had brought the market so far, but without real improvement to economic conditions on the ground. The markets had begun to meander till the Indian Meteorological Department sprung the magical good news about the gathering clouds.

The new-found optimism springs from the fact that the rural economy could see better incomes and spending power come Diwali. It has been badly ravaged by poor monsoons, smaller crops and falling rural incomes in the last two excruciating years of drought. While the rural economy may still seem small due to its only 15 per cent proportion in the GDP, it still plays a huge role in the incomes of the rural population. Nearly 50 per cent of the working population depends on the agriculture sector and related activity.

Says Ajay Bagga, markets experts: “The good news about the monsoon has clearly buoyed sentiment and, from a two- or three-year perspective, things are looking up because some of the good work on the economic front is falling into place. Investors should start looking at good companies where valuations are still quite low.”

The rural economy, of course, is not the only factor that had been slashing into India’s economic growth. But the fact that it was contributing to lower domestic demand has been hurting Indian equities. Says Bodke: “The distress in the rural sector was evident from the sales of two-wheelers and tractors. The fact that the talk is about a normal monsoon has bought cheer to the many sectors that would turn out beneficiaries.”

Growing Confidence
Despite the fact that the economy has yet to fire on all cylinders, the confidence is beginning to show due to two crucial pillars of the market. Of the four pillars of the economy, according to Bagga, two are looking good; for the third, though, recovery is just a matter of time.

“Exports continue to be low and, probably, would take time to recover. Domestic capex will take time, too, as there is still much under-utilised capacity. Public expenditure, however, is rising slowly, and the fourth pillar of domestic consumption is looking better now due to forecast of a normal monsoon,” says Bagga.

Besides, now being played out is the beneficial interest-rate environment. The RBI has already hinted that if the monsoon is normal and inflation is trending toward, and holds within, the comfort zone, the apex bank could continue with its accommodative stance. This means another cut in the interest rate could be in the offing. This could come in July or August when the rains have been seen to be well distributed, and the US Fed rate hike due in June is dusted off and done with. A rate cut just before the festival season would be the right tonic for the consumption sector.

Already, the RBI has effected several changes to the liquidity measures. Says Bodke: ”The kind of seminal measures he has taken on the liquidity front, that itself has brought about a sea change in terms of how bankers could pass on the rate cuts.” In short, consumption is likely to lead to a strong surge in demand, and interest-rate-sensitive sectors are in for much better days. This would lead to a further upswing in demand for two-wheelers, autos, houses and white goods.

Experts are also pointing out that an increase in incomes of households due to the implementation of the 7th Pay Commission and OROP. The government has budgeted nearly Rs 90,000 crore on expenditures towards this in Budget 2016. In coming months, this will begin to add to consumption demand. Says Vinay Khattar, Senior vice president and head, research, Edelweiss Securities: “Our sense is that demand is going to pick up very aggressively especially after the Pay Commission monies come into people’s bank accounts, with states then expected to follow. So, consumption should see a strong pick-up.”

Khattar also points out that the infrastructure segment is gaining good traction. “Infra demand is picking up, as order books are seeing some growth. System-wise utilisation levels, which are currently at a low, should begin to step up in coming quarters. So, now, this is a good time to invest.”

Right Time To Invest
Hence, while the monsoon clouds spell good news for the rural skies and segments, and for public expenditure on infrastructure, they also signal the beginning of the investing season. Investors, who have been sitting on the sidelines waiting for some good news concerning the economy and markets, could re-visit the Indian markets. Agrees Bagga: “These are just the right times to invest. Valuations in many pockets are low. Besides, there is under-investment in the markets and domestic investors are sitting on cash, which would once again enter the markets.”

Of course, when things get a bit too rosy, it’s also prudent to scan for risk factors. Currently, among the many risk factors, global growth and a US Fed rate hike are two of the biggest. At present, billions have entered emerging markets through the ETF route. And as this is hot money, it could fly off on any negative news in the US economy as quickly as it came rushing in. Pension and long-only funds are still shying away from exposure to global emerging markets.

So keep a keen eye out for the volatility, if any, and hold on to some buffer funds to buy on dips. Says Khattar: “In case markets crack because of the US Fed, India would see a sympathetic reaction. But, the overall India story would continue to be strong.”

While much hinges on fund flows into the market, investors should also keep an eye on the distant horizon, and look at companies that command higher growth and lower leverage. Says Bagga: “You have to invest with a long-term perspective. Stay with companies with low leverage and high growth. You have many other cases such as private-sector banks, non-banking financial companies, consumer companies, IT, pharma and auto. Besides, cement is under-valued as capacity utilisation in cement is low and demand is steadily picking up. This is where the operating leverage will come into play.”

PSU Banks A Concern
Bagga also reckons that public-sector banks would continue to pose a challenge because hidden non-performing assets could probably continue to be a factor for at least two quarters more. On mid-caps, says Bagga, “investors should come through mid-cap mutual funds because tracking the many mid-cap companies may pose a challenge to investors.”

Mid- and small-cap stocks are more expensive than large-caps. At present, large-caps are trading at around 18 times earnings, which is marginally higher than the past averages of around 15 times earnings. However, mid-caps are trading at significantly higher valuations and, hence, investors should tread here with caution.

A mild pick-up in earnings is also on the cards in the fourth quarter, which is expected to be the best quarter of the last five, with revenue and profit growth expected at around 2-5 per cent because of the smaller base. This should drive earnings higher and make valuations of large-cap stocks look a scrap more comfortable.

Overall, the confluence of good news across various parameters is probably arriving at an opportune moment for investors. Last year’s contractions in equity prices have resulted in some frothy valuations blowing off, and shrinking to more realistic and inexpensive levels for investors than they were a year ago, making it a good market for buyers with a long-term horizon.

If you are among the ones who would prefer to leave the task to specialists, you could also look at diversified equity mutual funds that have a value and large-cap orientation, as foreign investor buying will drive up the larger counters up initially.

Says Bodke: “The markets are poised for a strong run from a two-three year perspective. It’s a confluence of global and domestic factors, and the fact of no fears of aggressive rate increases globally would underpin a sharp rise in markets.”

Will The Turnaround Sustain?

1. An above normal monsoon will drive rural incomes higher and is expected to reflect in sales of automobiles and other white goods

2. Stocks have risen by 12.5 per cent since the budget, but are still way below frothy valuation levels seen in early 2015

3. A pick up in infrastructure spends through public expenditure is expected to drive the operating leverage of select sectors

4. The increase in spending power due to the 7th Pay Commission reward and OROP will put more money in the hands of consumers

5. Large-cap companies are relatively undervalued as compared to mid- and small-cap companies. However, be selective

6. Foreign inflows have been robust as the US Fed may go slow on rate hikes and QE continuing in Europe and Japan

7. Domestic investors are sitting on the sidelines suggesting an under-investment in the market and could stage a comeback soon

8. Investors could go about investing in a slow and steady manner while focusing on high growth companies with low valuations

clifford.alvarez@gmail.com