Deutsche's 6 reasons why the rally still has steam in it

moneycontrol Bureau

Equity benchmarks Sensex and Nifty have rallied over 21% since the start of the calendar, with a sizeable chunk of gains coming in the last couple of months. Many players are doubtful if the uptrend can sustain, given the weak macro-economic environment. And while the government announced a slew of measures in the last few weeks, the widely held perception is it will take a few more quarters for the economy to show any signs of revival, and that the market may have run ahead of fundamentals for now.
But brokerage house Deutsche Equities feels the rally still has steam left in it. Its strategists Ajay Kapur and Titesh Samadhiya have put out a note listing six reasons why investors should continue to buy Indian shares.

1. Sentiment:  Widespread investor skepticism, based on our recent travels around the world meeting clients, including India last week. We found a handful of bulls, but the vast majority was well-informed skeptics/bears.
 
2.  Money supply: Weak monetary base growth is an excellent bullish sign for Indian equities on a one-year horizon, with average returns of 21% well above base case returns of 16%. Currently, monetary base growth is running at 4.4% y-o-y. When monetary policy is tight and begins to ease (monetary base growth picking up), Indian equities tend to oblige and rally hard.

3. Twin deficits are good for equities: When the twin deficits (current account plus fiscal deficit) are high like now, something happens-policy reforms get enacted while valuations already reflect the grim situation. Prospective returns from these diabolical twin deficit levels are exceptionally good.

4. Good valuations, and lows in EBIT and RoE, a contrary signal:  We estimate that ROEs and EBIT margins are in the lowest quintile in the last two decades and are likely to rise as prior under-investment, policy reforms, contained commodity prices from a slowing China, and increases in infrastructure spending kick in. We think both ROEs and EBITs are likely to proceed back up to long-term averages (19% and 16.5%, respectively)

5. More reforms: Investors should expect a continued slew of reforms, project approvals and possibly a budget next April that also surprises positively, despite being the last likely budget before the next general election. This view is our conclusion from our meetings in Delhi, the PM’s legacy issues and his linking economic growth and national security, the energetic team leading the reforms, and the optionality for the Congress in the next general election.

6. Price earnings (ratio), productivity enhancement, stronger GDP growth: Over the longer term, we believe three main things drive equity returns. The Demi-Ashton ratio (people in their 40s to 20s) drives the PE multiple (and productivity); prior over-/under-investment and government policy drives the profit share of GDP; and working-age population growth is a key driver of nominal GDP growth (and property prices). All three drivers look great for India but problematic for China.

The brokerage is advising its clients to buy a "rural basket, an infrastructure basket and select financials."