Equity markets are looking extremely buoyant at the moment, the strong political mandate won by the newly-elected Government being the key change.
Importantly, the focus of this Government appears to be on getting back to a stronger growth trajectory.
Over the past six years, equities have returned 3 per cent per annum. During the same period we have seen other asset classes, such as gold (13.4 per cent), debt investments (8.5 per cent) and real estate (8 per cent) deliver more. This was purely a cyclical phenomenon driven by the global financial crisis and flight to safety. Equity returns were further impacted by the high sticky inflation that compelled the Reserve Bank to raise interest rates, rising current account deficit and falling growth.
Now, however, it is important to take cognisance of the macro parameters that have undergone significant overhaul. The relatively high inflationary nature of the Indian economy in comparison with the rest of the world demands that investors plan and select asset classes that are able to maintain the purchasing power of their capital.
Political stability
Equity is the only asset class which decisively beats inflation over long periods of time. Gold and real estate do well only on a cyclical basis, they are not a substitute for equities. Unfortunately, Indian households allocate a very low proportion of their assets to equities. At this time equities form only 1.5 per cent of household savings, down from the peak of 7 per cent in 2008.
There is a tendency on the part of retail investors to look at historical returns and then rush to invest. This was the case in 2007-08 when the mutual fund industry also got its highest inflows at the market peak. All asset classes go through cycles and now it’s the time for equities to deliver returns better than other assets, such as gold, real estate or debt.
Indian households’ equity allocation needs to be corrected and should increase substantially at this time to take advantage of favourable conditions over the long term.
Over the next five years, with a stable political regime, with key policy initiatives by the Centre, we believe GDP growth can average 6.5 per cent (nominal growth of 13 per cent).
Further, with increased economic activity (driving higher sales growth), operating leverage and financial leverage will aid improvement in corporate profitability. This can drive around 20 per cent growth in profits (during 2003-08 net profits grew by 27 per cent).
Additional upside would emerge from further expansion of price-earnings multiples due to improving growth.
Should you book profits? The rally in the benchmark indices in the past three months has been very sharp at about 16 per cent. At the same time, the stock returns are widespread and not restricted to large-caps alone.
In fact, many small- and mid-cap stocks have delivered 50-100 per cent returns. In such a context, it is natural for investors to think of booking profit. During any revival the returns are bound to be sharp. Investors booking profit now will miss the opportunity of wealth creation through compounding over a longer time horizon.
(The writer is Co-Chief Investment Officer, Birla Sun Life Mutual Fund)
(This article was published was originally published in >The Hindu Business Line. on July 6, 2014)
