Unless the US faces a prolonged and deep recession, we do not expect a large adverse and prolonged impact of the same on the Indian equity market, says Pradeep Gupta, Co-founder & Vice Chairman at Anand Rathi Group. In an interview with MintGenie, Gupta explained why he believes India remains a long-term story.
What is your view on the current market structure? Are you concerned about the rich valuation?
Until recently, the global, as well as Indian equity market, remained in the corrective mode for more than a year since the middle of October 2021.
In the meanwhile earnings of listed companies in India have expanded substantially. Consequently, the valuation of a large part of Indian equities was looking attractive before the recent rally started.
Currently, while there are both upside and downside risks to the Indian equity market, the market is likely to remain volatile without going strongly in a particular direction over the next three to six months.
As compared to the average of the last five years, currently the valuation multiples for the Indian equity market measured in terms of price to earnings (PE) ratio looks reasonable if not attractive.
The multiple, however, looks slightly elevated as compared to the last 20-year averages. In any case, we do not see a huge froth in terms of Indian equity market valuation.
At this point in time, I think that possible earnings disappointment is a bigger risk rather than the steep valuation for Indian markets.
What, in your view, makes India an attractive market for the long term? What are the macroeconomic positives and what are the challenges that you see?
In the longer term, the equity market is driven primarily by three factors.
These include fundamentals, both macroeconomic and corporate, liquidity flow towards the equity market, both domestic and foreign, and valuations.
India has made tremendous progress in terms of macroeconomic fundamentals during the last 25 years. India's global ranking in terms of the size of the economy has improved from 16th to 5th.
In terms of output for all sectors and segments of the Indian economy including agriculture, industry, services, private consumption and fixed investment, India’s global ranks have improved significantly in the last two and half decades.
According to the forecast of the International Monetary Fund, India is likely to be the fastest-growing major economy in the world in all years from 2022 to 2027.
Therefore, India remains very attractive in terms of macroeconomic fundamentals.
The corporate fundamentals, especially in the last couple of years, have improved even more than the macroeconomic fundamentals.
So this is also another area where the Indian market becomes very attractive from a global perspective.
Since 2000, the share of equity investment by Indian households in overall savings is increasing continuously.
Over the last five years, a major part of the investment in equities is coming through systematic investment plans in the units of mutual funds.
Therefore, the domestic money flow towards the equity market is the major strength of India. India also attracts 2-3 percent of global cross-border portfolio equity flows.
Since the year 2000, India experienced net cross-border portfolio equity investment outflow only in three years, 2008, 2011 and 2018. The current year is also likely to be an outflow year.
Yet, going by past experiences, whenever there has been an outflow of portfolio investment from India, in the next couple of years India receives a large amount of portfolio equity inflows. From that perspective also India looks attractive.
I have already talked about the valuation of the Indian equity market. I think Indian equities are close to fair value.
Therefore, on all three accounts that is fundamentals, liquidity and valuation Indian equity market remain attractive from a longer-term perspective.
The macroeconomic positives for India at this point in time include the best GDP growth rate among the systemically important major economies picking up in the domestic investment cycle strong credit growth falling inflation significant overachievement of government revenue and lower than budgeted expenditure.
The negatives for the economy include subdued growth in deposits underperformance of exports versus imports and subpar performance of the manufacturing sector.
Will India suffer significant pain if the US goes into a recession? How can our market react to a recession? Will there be a prolonged selloff?
There are significant linkages between the Indian markets with the global market through foreign trade, internationally-linked commodity prices, cross-border capital flows and a common investor base.
More than half of the free float market capitalization of the Indian equity market is controlled by foreign investors.
Therefore, India cannot remain immune to any downturn in the global economy.
That said, like most of the major economies including the US and Japan, the large size of the domestic market significantly reduces the impact of external development on the Indian equity market.
Past data suggest a positive correlation between GDP growth in the US and India's equity market performance.
Therefore, if there is a recession in the US then the Indian equity market is likely to get impacted adversely.
Generally, a recession in the US brings down earnings growth for the Indian corporate sector and consequently the stock market return plummets.
On average, during a phase of rescission in the US, the Indian equity market delivers a low single-digit return in a 12-month investment horizon.
The impact of a recession in the US on the Indian equity market will depend on various factors.
The extent of output contraction in the US and the phase for which the GDP of the US contracts will be major determinants of the impact on Indian equity markets.
Unless the US faces a prolonged and deep recession, we do not expect a large adverse and prolonged impact of the same on the Indian equity market.
What sectors one should bet on now? What sectors should one avoid?
We like financials, information technology and the capital goods sector. We are negative on sectors linked to the consumption theme. We also are not positive about global cyclical like oil and gas and metals.
What should be an ideal portfolio in times of uncertainty in the market? Should we hold more cash?
While Indian equities are the best asset class in terms of risk-adjusted return in the medium to longer term, they can be volatile in the short term.
Therefore, we recommend our clients invest in equity assets with at least a three-year investment horizon.
For such clients, asset allocation should be based on strategic considerations including the expected cash flow, risk appetite and investment horizon rather than market sentiments, short-term news flows and perceived market outlook.
Therefore, we do not advise our clients to adjust their asset allocation on a frequent basis.
Our experience suggests that it is asset allocation which decides over 90 percent of portfolio return in the longer term rather than efforts to time the market.
Timing in the market on a consistent basis is extremely difficult.
Moreover, our calculations suggest that even when an investor is consistently right about the likely phase of market movement in the future, longer-rem (three-year and above) the portfolio return does not vary significantly irrespective of whether the investment was made at the peak of the market or after the market has corrected up to 30 percent from the peak.
Therefore, we do not see much reason to maintain a high allocation in cash during the phases of market uncertainty.
The cash portion in the portfolio should be kept high only in phases for the investor expects anticipated cash outgrow for certain large expenses in the near future.
We see an influx of retail investors in the market. Their numbers have increased exponentially in the post-Covid world. What advice would you give to new and inexperienced investors?
My first advice to such investors would be to invest in equities for the purpose of longer-term wealth creation rather than shorter-term speculation or trading.
One should give equal importance to both expected return and risk, particularly when investing in equities.
Second, one should not invest in equities unless the investor has at least a three-year investment horizon.
Third, for most retail investors who do not have much time or expertise to actively manage their direct equity portfolio, it is better to take equity exposure through units of diversified equity mutual funds.
Fourth, timing the market consistently is extremely difficult and even successful timing of the market does not necessarily increase portfolio return significantly.
Therefore, for a better long-term return, one should remain invested in the market rather than speculating about the expected market movements.
Disclaimer: The views and recommendations given in this article are of the analyst. These do not represent the views of MintGenie.