Why Stock Market Is An Ideal Investment Option

Year 2015 ended with the Sensex yielding about -5% returns but that does not convey the entire story. The Mid cap index gave a return of 6%, a classic signal that mid cap stocks have finally come of age in India. Even within the overall equity space, stocks in sectors like consumer durables, pharmaceuticals and IT managed to outperform, while sectors like oil and metals tended to lag due to obvious reasons like global crude prices and weak Chinese demand. The moral of the story is that for any long-term investor, equity investment still offers the best bet to create wealth in the long term. As we embark on year 2016, let us understand why equity investing is the ideal choice for the Indian investor.

There is a global commodity-price dividend…

What exactly is this commodity dividend? When prices of commodities like oil, zinc, iron ore and other minerals fall, it translates into lower cost of production for other industries. This reduction in cost directly translates into higher profits for Indian companies. Then why has this not benefited India? The reason is that most of the stocks in the Sensex and Nifty are dependent on commodity prices. Companies in the steel, aluminium and oil industry are classic examples. On the other hand, mid cap stocks have actually been beneficiaries of the low commodity price dividend and that has shown in their performance. This fall in commodity prices is not only advantageous to corporates but also to the Indian economy. It keeps fiscal deficit and the current account deficit in control and that keeps the rupee stable, which in itself is a positive scenario for equity investing.

Big bang investments coming up in 2016…

The government is planning big bang investments in the year 2016. There is the Rs.41,000 crore highway project in the state of Telangana which is likely to be a boon for road developers and construction companies. Then there is the major indigenisation effort on the defence front. Make in India is going to be a strong story for the defence industry.  As defence opens up an opportunity for Indian companies, those with exposure to defence contracting will see direct benefits in terms of top line and bottom line. Mega projects like the bullet train project also will have tremendous spill over effects. In the light of such massive investments, equities will be the obvious beneficiary.

There is still room for rate cuts…

The RBI has cut rates by 125 basis points in the last one year and it looks poised to cut at least another 50 basis points during the year 2016. Of course, the US Fed decision is an overhang but as long as the US Fed does not go outside its trajectory of 100 basis points, the RBI will be on target for rate cuts. A rate cut will benefit equities in two ways. Firstly, the lower rates will be a direct boost for the rate sensitive stocks in sectors like banking, real estate and automobiles. Secondly, the interest rate goes into the calculation of risk-free rate which is used to calculate the cost of capital. Thus, lower the cost of capital, higher the present value of cash flows and therefore higher the fundamental valuation of the stock. Typically, Indian stocks have enjoyed better valuations in a falling interest rate scenario. The rate cuts of 2015 will be reinforced in 2016 and that will be positive for equities.

Indian markets are reasonably valued on a PEG basis…

It is easy to get carried away by the P/E argument. Indian P/E may be above other competitors in emerging markets but there is a reason for that. Firstly, unlike other emerging markets like Malaysia, Indonesia, Brazil or Russia, India is not dependent on commodity exports. Secondly, Indian trade is not overly dependent on China unlike countries like Singapore, Philippines, Japan, Australia and Canada. Hence, India is in a better position to weather the economic slowdown in China.

P/E of 15 for India on a forward basis is justifiable on 2 grounds. Firstly, it is only marginally higher than the historic average P/E of the Sensex at a time when the Indian markets are at a cusp of a major multi-year growth. Secondly, when the P/E is looked at in reference to the growth in earnings over the next 3 years of 14-18%, it surely looks a reasonable valuation. That once again makes a case for equity investing,

Global investors are likely to return to risk-on trade…

Let us understand what we mean by a risk-on and risk-off trade. A risk off trade is when most of the investors prefer the safety of bonds and look for safety in developed markets like Germany, Denmark and Switzerland. But these markets cannot give good returns to investors. Most large investors were risk-off in the last 3 years due to fears of a US rate hike. Now that the rate trajectory is known, we may see a lot more of risk-on money coming into India. Investing in India has some key advantages for foreign investors. The currency is stable and is not as volatile as many other emerging market currencies. This will ensure that their dollar returns are not eaten away by the rupee depreciation and that gives them confidence. Also in terms of market structure and regulation, Indian equity markets are at par with the other major markets in the world and this gives them the comfort level. A return of the FII investments will be a big positive for Indian equity markets.

Indian earnings growth is in a sweet spot…

After lagging China for nearly 25 years, India’s GDP growth has finally crossed Chinese level this year. In fact, in the coming year, India is likely to be the fastest growing large economy in the world. What better way to play this GDP story than buying Indian equities. But the bigger story lies in how the earnings of Indian companies are likely to grow. In the 2003-08 period earnings of Indian companies grew by a CAGR of 21%. This rate of growth fell sharply to just 8% CAGR in the 2008-14 period. Now Indian companies are in a cusp of another earnings boost as low commodity prices and the explosion of the Indian domestic market is likely to combine. Indian corporate earnings are likely to grow at nearly 18% CAGR in the next 4 years and that will result in tremendous value creation in equities. The earlier you start, the better positioned you are to create wealth through equities.

Finally, there are not too many alternatives…

Remember Indian households are awfully under-exposed to equities. A chunk of savings still goes into bank deposits, fixed deposits, gold, real estate and insurance. Now all that is likely to change. Gold has given negative returns for the last 5 years and people are already looking to diversify out of gold. Real estate in India has been too erratic and unorganized and it is not promising the kind of returns that it used to give in the past. Debt may be attractive for now but with falling interest rates that may not be the case. The government has now decided to subject small savings also to market interest rates and that is not great news for small savings investors. That probably leaves you only with equities to beat inflation and also create wealth in the long run.

It is interesting to note that in the last 1 year, nearly 50 lakh new equity mutual fund accounts have been opened and Indians have invested nearly $15 billion in equity mutual funds. Indian households are expected to invest close to $75 billion into equities over the next 3 years and that can make a world of difference to valuations. The time to start getting into Indian equities is now. Remember, it is always the early bird that gets the worm.