We have an optimistic case for equities in the year 2014. For the last six years, from the previous peak of January 2008 till now, the market has virtually remained flat. Within the same period, there has been a huge shift in the market between the stocks which FIIs, like and those they do not like. It is no surprise that the stocks which have caught the FIIs fancy have been trading at all time highs, whereas other sectors, like PSU banks have been trading at lows. No doubt there are challenges faced by these sectors which are underperforming but the valuation gap has never been so stark or evident. FII investments in the domestic market have increased in the last five years; now they own 21.3% stake in BSE 100 companies (as per September, 2013 filing) as against 14.2% in 2008. All this when domestic institutions? share has virtually remained flat at 11.6%, retail investors? share declined from 6.5% to 5.9% and promoters share fell from 56.9% to 48.3%.
Both DIIs and FIIs have concentrated holdings. Just about 15 stocks currently account for 64% of FII total holding in BSE 100. The figure is similar for DIIs. Such concentrated holding has resulted in a huge valuation gap between the favourites and the not so favourites. Since Jan ?12, the FII inflow as a percentage of market cap was the highest for India amongst the emerging markets and the Indian market has a high correlation to FII inflows. In the last ten years, we have seen three bull runs, including the bull phase of April 2003 till December 2007 when the Sensex return was at 597%, the bull phase of March 2009 to November 2010 when the Sensex return was 152% and the bull phase of December 2011 to date when the Sensex returned about 35%.
A new bull market appears to be on the anvil. The Indian economy is expected to bottom out in this or the next quarter; in fact it is showing some signs of revival though we may not witness a sharp upward movement. The benefits of a good monsoon will provide a booster to rural economy and the agriculture sector. With the US economy slowly coming out of the woods another avenue will open for services led by IT and pharma.
As the economy recovers, earnings for the companies will also pick up leading to a rerating of the market. We have witnessed an earnings downgrade cycle in the recent past. As the economy picks up, we will see the earnings upgrade cycle akin to 2003 ? 2004, which saw the biggest bull market in India.
For the last five years, since Jan ?08, much money from the retail investors have flown into fixed income, gold and real estate. Last year, in dollar terms, gold had the worst performance when it fell almost 33% over a year. And hence gold will lose its shine as an investment opportunity. The Indian gold prices, have not corrected so sharply simply because of rupee depreciation and restrictions imposed by the regulator. In real estate, there are delays in execution. The overall slowdown in the economy coupled with high interest rates means real estate prices are not rising as sharply as in the past. There is little evidence to show that price has already corrected in major markets like Gurgaon, Noida, some parts of Mumbai and Bangalore. If two big assets classes or investment opportunities are getting out of favour, then we may see the bulk of money coming back into equities as the stock market starts performing. In India, very little retail investment savings come into stock markets. Even a 1% increase in household savings will bring in almost $ 3.6 billion into equities at FY13 savings rate. We expect this shift to happen in the coming years. The shift will be gradual but still can provide a large amount of liquidity into the market.
There is only one uncertainty in the pack, which is the elections. Clearly, the market seems to be factoring in a BJP-led government at the Centre, with Narendra Modi as Prime Minister. Five months is too long a period to predict the elections. Irrespective of which party comes into power, they will take steps to kickstart the economy. It is clear that high inflation and slow economy hurt the prospects of political parties. This is one lesson that all the political parties have learnt and they will take all steps to kickstart the economy at the earliest.
Sectorally speaking, for the short term, we advise the investors to align their portfolio towards export-oriented sectors like IT and stocks like Infosys and HCL Tech. Within pharma, we like Sun Pharma and Torrent Pharma. FMCG stocks are very richly valued and this point in time incremental returns will be limited given the dream run for the last five years. One can buy quality stocks like ITC and HUL and they can continue to form part of the core portfolio of any long-term investor. A risky trade which might play out in the next two-three years will be increasing exposure to PSU banks as well as domestic cyclicals and engineering like Thermax, BHEL, ABB, Siemens and Bharat Forge among others.
The author is managing director, IIFL
