ATM :: Why this is a good time to invest in equities

Sep 23, 2013, 10.22AM IST | Saurabh Mukherjea | Economic Times


In August there was a lot of pessimism around the rupee and the Indian economy at large. In September the markets have recovered. Sensible investors should not make too much of either the earlier pessimism or get too carried away by the current optimism.

The pessimism around the currency was overdone. The RBI governor has addressed some of the issues though I don’t think we are out of the woods yet. Broadly we expect the rupee to stabilise between 57-58, which is its fair value, and 65, which is the level to which the RBI will let it drop.

Why invest in stocks now

There are four compelling reasons for investing in equities at this juncture. First, if you look at the data for the past 30 years, our equity markets broadly move in five year cycles. Since returns from the stock markets have been disappointing in the past five years, there is every chance of mean reversion. When returns have been poor and the broad swathe of the investing public is shunning equities, that is the best time to buy stocks.

Second, it has been widely commented that the Indian economy has suffered due to the government’s policy paralysis and that the India growth story is structurally damaged. I believe this whole “structurally damaged economy” hypothesis is overly pessimistic. Like any other free-market economy, the Indian economy too goes through its cyclical ups and downs. We are probably at the bottom of an economic cycle and will emerge from the trough in the next year or so, hopefully helped by favourable election results. As we emerge, the stock markets will pick up in anticipation of growth.

Three, most economies, whether the Western economies or the BRIC countries, are now locked into each other through trade and capital flows. Hence we are all part of a single global economic cycle now. As the global economy bottoms out and starts recovering, we will see the benefits flow through to India as well. This is the reason why you should discount the notion of structural damage to India and to the BRIC economies — it makes for good press copy but is not grounded in the underlying economic realities of the world we live in. The US economy has recovered first, Europe seems to be next in line, and we will follow in due course.

Valuations provide the fourth and final reason. The Nifty is trading at a good 15-20% discount to its 10-year average valuation. But more compellingly mid- and small-cap indices are quoting at their highest ever discount compared to the large-cap indices.

Growth will rebound

If you examine the various components of our GDP, agriculture has turned. In years when the monsoon is good, agricultural growth tends to surprise on the upside. But agriculture is only 15% of our economy. Next, look at exports. From a negative 1% growth for the year ended March 2013, we had 12% growth in July and 13% in August. The data we are getting suggests that between now and December (the final four months of this calendar year) we are likely to have 22% yearon-year (y-o-y) growth. So the export sector is gathering speed, propelled by a weak currency.

Government spending is also picking up in the run-up to the elections. If you compare the first six months of the current year with that of the last, government spending is already up 14%. In the December quarter of 2012, the finance minister had slashed government spending to contain the fiscal deficit. So on a y-o-y basis, government spending is likely to be much higher in the last three four months of this calendar year and that will stimulate growth significantly.

Due to all these factors, growth in the second half of the year is likely to be better than in the first half even if industrial output remains subdued. It should be around 5% compared to around 4% in the first half. Hence GDP growth for the financial year 2013-14 should be around 4.7%. While this is not a very impressive number, the key point here is that we are on the cusp of a turnaround.

Where should you invest?

Currently you should invest in cyclicals, mid and small-caps, and value stocks. The premium that investors are paying for defensives is at an all-time high. This does not mean that defensives will crack very soon. But it does suggest that the fear about the economic cycle has been overdone and hence investors have over-bought defensives. Since we believe that the economy will recover, we expect this fear to dissipate, defensives to underperform, and cyclicals to outperform. Second, at no juncture in history have mid- and small-cap stocks traded at such a steep discount to large caps. That discount is again the result of widespread fear about the stability of the Indian economy.

As the fear dissipates, this discount will vanish. Third, over the past 15 years value stocks have outperformed growth stocks. But in the past three years the opposite has happened. Growth stocks are safe, well known, safe-haven plays. Many of them are in the consumer- or export-oriented sectors. They have done well and hence growth has outperformed value. The avoidance of value stocks and the pre-eminence of growth stocks is again a manifestation of fear and risk aversion. As these abate, value stocks will once again enjoy a good run.

Finally, the Indian market is at a nascent stage in its evolution and is hence very volatile. Investors should only put that money into the stock markets which they can afford to lose. Also, have an investment horizon of at least three years. If you have a shorter investment horizon, you will make it difficult for yourself to profit from a relatively risky activity such as stock market investing.

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