The cyclical pick-up in growth is being ignored by the market obsessed with bold policy and reform moves by the new government. Of the many variables that make up the market’s macro ecosystem, growth is unarguably the most important, because its relationship with the market is quite unequivocal and straightforward—rising growth is strongly correlated with a re-rating of the market’s earnings multiple, while falling growth is correlated with a de-rating of the market’s earnings multiple.
It is instructive to see how sequential growth—backed out from de-seasonalised data series, with a focus on direction rather than magnitude—is faring, as opposed to year-on-year changes, which can be susceptible to distortion by base effects. We find that sequential growth momentum has been on the rise since the beginning of this year for a number of demand, supply and real activity indicators. This is relevant in the current environment because the market’s obsession with larger bold (and thornier) policy and reform issues as proof of the government’s reformist intent can potentially lead to the ongoing incipient growth recovery already underway to be overlooked.
There have been two key drivers of market performance from the bottom in early September 2013: (i) significant improvement in the market’s macro ecosystem; and (ii) election-led euphoria which does discount expectations of some pick-up in growth. However, the market’s earnings multiple is still not expensive.
Our hitherto positive call on the market was underpinned by our bullish stance on rate cyclicals, essentially because we expected inflation to surprise positively in the coming quarters on fiscal consolidation, a stable currency and normalisation of seasonal food prices. With the worst of inflation now behind us, we are seeing signs of an incipient cyclical recovery coming through following a reduction in policy uncertainty and an appreciable easing of macro pressure points.
We expect growth momentum to intensify in the medium term on the back of ongoing efforts of the new government to revive growth, and for the market to re-rate on the back of tailwinds arising from both falling inflation and rising growth momentum.
As a reflection of our positive view on growth, we are upgrading our underweight stance on autos and industrials (infrastructure, construction and capital goods) to overweight. Marketwise, our new August-end 2015 Sensex target is 30,310, which offers a potential 20% upside from current levels based on a conservative 12% earnings CAGR for FY14-17F (vs. consensus at 15.5% earnings