The broad risk to rally is what is happening globally. The global risk factors have gone up- both political and financial risks are high. Market valuations are high globally. A cut in global growth assumption can trigger a correction. Currently, the markets believe that there is reflation- in both US and China. In case there is a change in growth assumptions there, the markets could see some correction.
The market valuations will not change till we see anything significant in terms of a change in Govt.’s policy direction. Valuations are high across global markets. That said, India’s proportion of corporate profits to GDP has dipped to an all time low and this will improve. Earnings growth will rebound and hence, it is difficult to say the market valuations have peaked.
We will have to wait another six months for earnings to start growing. A lot of structural reforms happened recently, which is good for the country but challenging in near term. The country is undergoing the biggest political economy reform in its history, which will boost tax revenues over the long term. In the near term, however, there will be disruption due to compliance with the new norms. The good thing is all this happening at a time when crude oil prices are under check and that has helped keep inflation manageable.
Both FDI and FII investments in India has remained healthy. Most people will be surprised by the pace of earnings rebound when that happens. The markets can give a compounded annual growth of at least 15% from here for next 3 years. This is a conservative estimate which can easily be exceeded. I expect annual earnings growth of at least 15% over next 3 years. It could be over 20% in case interest costs fall and get reflected in the bottomline. That said, the rupee has to remain supportive.
The recent FII outflow was profit booking. The markets have not stopped performing despite FII outflows as there have been inflows from domestic funds. Equities offer one of the best return potential among all the asset classes. Domestic flows should continue to remain strong. If there is a geo-political event, I think India will be seen as a relative safe haven within Asia.
The domestic investment cycle related sectors are likely to lead the next leg of market rally. Capex and industrial led ones will outperform. Export oriented sectors have their own issues. I don’t see major rebound in information technology and pharma in the near term. That apart, the private banks and select public sector banks should also do well. Consumption, esp. automobiles, should also do well. Portfolio strategy depends on the individual investor and their personal circumstances but generally I would say we still are a ‘buy on dips’ market rather than ‘sell on rally’ one.