Samvat 2076 - The way forward

Samvat 2075 has been a truly troubling year in the capital markets. India’s macro growth has sputtered to a four-year low (5%), rising stress is being reported from its financial system (esp. NBFCs), high-frequency indicators like auto sales volumes, indirect tax collections and credit growth have fallen while government bravely continues on the policy reform path, spends aggressively on mega-infra projects and struggles with legacy issues. Long term investors have lost money in many (if not most) of their conviction stock picks, with super-normal returns being concentrated in an ever narrowing band of high quality companies. Traders have seen higher volatility with persistent and disruptive changes in corporate strategies, business models, government policies and geopolitics.  

The Indian economy has indeed performed lower than expectations; growth in the last quarter was not only disappointing in absolute growth rate, but also relative to expectations. The conditions currently may be deemed to be a severe slowdown or a mini-recession, though there is a fear among some market participants that this can be a protracted recession. Recessions don’t last forever; however, what will determine the future direction of equity markets is timing of economic recovery. 

Which brings us to the key question this Diwali - what should the Indian investor do?  

It’s not just business models, processes and strategies that are undergoing disruptive change. The rules of doing business and behavior are changing in India. GST is driving up formalization. The use of cash in retail trade is falling. Household savings are getting more financialised (into mutual funds, insurance and direct equity) as the lure of real estate and gold falls (though the lure of fixed income stays given the wealth erosion in equities seen lately). In the last 18 months, net equity inflows into MFs are mostly attributable to SIPs and not discretionary investing. India’s millennials want a rule-based economy with higher consumption and comfort levels. Their choices are radically different as evidenced in their preference for a compliant, sharing and digital economy – whether it is car rides, shared apartments, Netflix or online shopping. 

The global economy though not supportive is unlikely to derail growth prospects for the Indian economy. However, the drivers of growth for India are likely to change, and this has implications for investors. While private consumption has led growth accompanied with a declining household savings rate, we feel that the savings rate is likely to start rising and staple consumption growth may find newer avenues. We believe that the next growth cycle will be led by capex spending. The capacity utilization rate is rising and is currently 76.1% indicating that many industries shall be thinking of expanding capacity.  

 We also expect credit demand to remain high, and along with the NPA issues having peaked, banks should gain. Also, the conditions for mid and small caps to outperform are broadly in place. The first is that markets should be in a risk on mode, and secondly, mid cap valuations should be favorable compared to large caps. The markets should enter risk on mode later this year amid attractive valuations. Investment portfolios need to be aligned to these changes to make the most of the next bull cycle.