Loose monetary policy is here to stay for some time
Sep 18 2016
Do you see some risks to Indian equities from an easy monetary policy environment in the developed markets, which could cause sudden exit of foreign equity investments and domestic investors could see their net worth eroded as it happened in 2008-09?
There are two aspects to this question – Is the easy monetary policy coming to an end; and if yes, then what implications do it have for the Indian equity market?
The easy monetary policy has its roots in the financial crisis of 2008. Loose monetary policy was seen as the panacea for all the problems as it was expected to trigger consumption and hence investments. But it seems that both individuals and companies have not gone down that path – individuals have turned savers and companies have been consolidating instead of expanding capacities. We do not see any signs of the same reversing in a hurry and, hence do believe that this loose monetary policy is here to stay for some more time.
In the event of this reversing, we do not see sharp contractions in the Indian economy as it depends to a large extent on domestic consumption and the interest rates here are still not ‘distorted’ (implying some sanity to the cost of money). The Indian equity market, however, may correct, as we are a lot more globally linked in investment flows than a decade ago. Withdrawals globally, from equity assets, may result in our market correcting, which to us would be opportunities for domestic savers to shift from ‘traditional’ assets to equity and benefit from the most tax efficient wealth-creating asset.
How do you see Indian equities performing this year with domestic economy looking mixed with hope of the farm sector doing well due to good rains but the corporate sector profits looking vulnerable due to uncertain global economy?
The equity market returns in the current calendar has been much better than expectations – delivering about 12 per cent returns year-to-date (YTD) and about 30 per cent from lows in February. India has been registering a healthy 7 per cent plus real gross domestic product (GDP) growth and with increasing inflation, it translates into better nominal GDP growth. In such a scenario, we do not see corporate profitability remaining subdued for long. Good rainfall after two years of poor rains creates a big delta in the lives of rural population. The urban population employed by the government, are celebrating an early Diwali as they got a good salary hike along with arrears in August, courtesy the seventh pay commission.
The remaining urban population, working with the private sector, has also been benefiting from a benign inflation. We, therefore, see Indian economy, and therefore, its companies doing well over the medium term. We may not be witnessing a healthy profit growth at the index level, but a number of companies have been growing earnings at a good rate and we should benefit by investing in them.
Primary market is doing exceptionally well this year so far. Do you see secondary market also peaking by the year-end or by the fourth quarter of FY17?
The earnings growth at the index level has been far from inspiring and therefore if we do not see the same improving over the next two quarters there may be a case for a correction in secondary market. But we are not of that camp and as highlighted above we actually foresee the earnings growth trajectory improves, going ahead.
How do you see GST impact the corporate sector earnings? Will it make equity investing more rewarding for the mutual funds and they can start investing in select sectors to reap the advantage as GST rollout is now certain and predictable?
It is still premature for us to comment on the impact of goods and services tax (GST), as we still do not know the final rate and its implementation schedule; hence quantifying its effect on corporate profitability is not possible. But we do believe that its implementation is going to simplify the processes for companies and provide “ease of doing business”. Thus, qualitatively, we can assume that it should drive certain cost efficiencies, which should result in corporate profitability improving. More importantly, this could free up management time, which can be directed towards growing the business.
India seems to be a great place for investing. But do you see current valuations attractive enough for foreign investors to allocate more money to Indian equities?
The Indian market at present is trading at a premium to our long-term averages. But the same has to be seen in the light of multi-decade low cost of capital. The chase for yields has led bond yields globally come down – very low single digits and in fact negative in certain developed markets. In such a scenario, investors find an opportunity in equity assets where the earnings yields are still healthy – north of 5-6 per cent (assuming PER of 15-20x one year forward).
India remains one of the few economies where the nominal GDP growth is still sustaining at about 10 per cent and lot of companies still earn RoCE of more than 12-13 per cent. In the last two years, the Indian rupee has exhibited much lower volatility, which gives a lot of confidence to foreign investors while allocating money. With such strong fundamentals, foreign investors would continue to invest in Indian equities.
Besides global liquidity, how has been the flow from Indian retail investors? Do you see retail inflows picking up as they did in 2014 and 2015 or there could be some profit booking from those who invested in 2014 and 2015?
In times of benign inflation and positive real interest rates, we have seen Indian investors choose financial assets as the mode of saving and they move to hard assets like gold and real estate when these conditions reverse. The last couple of years have been such times of benign inflation and hence positive real interest rates and we have seen investors increase allocations towards equity as an asset class. With a stable outlook towards inflation, going forward, we do not foresee the equity investments coming down.
What should be the strategy while investing in equity mutual funds and balanced funds in the context of current domestic and global factors?
We always recommend investors to choose systematic investment plans (SIPs) as the strategy to invest in the equity market because it brings an element of discipline to investments. We advise investors to use any sharp corrections in the equity market to allocate a larger amount in a “lump sum” manner as it helps lower the overall cost of acquisition and more importantly increases our total exposure to the asset meaningfully at a “good” price.