The ferocity of the rally has taken many by surprise. The Indian equity market has crossed the $3-trillion mark and the valuations do not look cheap now.
On traditional parameters such as the price-earnings ratio and/or price-book value ratio, the benchmark indices are at a 15-20 percent premium to long-term averages. The broad parameter of market cap-to-GDP is above 100 percent now.
Though there is a case for some cooling off in the markets in the short term, we continue to remain optimistic on the medium-term outlook largely due to three key reasons.
First, the second coronavirus wave is easing and the pace of vaccination is expected to pick up significantly in the coming few weeks.
Second, corporate earnings growth outlook is pretty strong with upgrade in estimates in last three quarterly season indicating a healthy growth of a 25 percent CAGR in FY22 and FY23.
Third, the Indian and most major economies are set to grow at a much higher pace over the next two years than the pre-COVID growth rate.
The second COVID wave is easing. New cases have dropped to below 1 lakh a day compared to a daily count of 3.5 lakh and active cases are falling steadily. A gradual withdrawal of restrictions has been initiated across regions and the life is expected to get back to normal soon.
The government's resolve to speed up vaccination will help bring back normalcy quickly. Thereby, easing the key risk to revival in economic growth and corporate earnings.
Second, in the short term, sentiment can move the needle beyond fair valuations on either side. However, markets are salve of corporate profit growth in the medium to long term. Corporate profits have surprised pleasantly in the past three quarters.
Corporate India's ability to adapt to changing dynamics and focus on cost control has helped mitigate the adverse impact of pandemic driven lockdown. Some of these margin gains are substantial in the medium term. Exports are also thriving with the US and large parts of Europe returning to normal.
Monsoon is expected to be normal for the third consecutive year. The aggregate profit of Nifty companies is expected to grow at a healthy 25 percent CAGR over FY21–23. Such phenomenal growth is coming on the back of six-seven years of muted gains in corporate earnings.
Lastly, the rising globally tide will lift all boats. Yes, the US economy and the leading European countries are set to grow at twice—or higher—the average growth rates of pre-COVID years of 2016-19.
Apart from the pent-up demand, the low interest rates and huge fiscal stimulus would push major economies into a higher growth orbit for many years. For example, the total stimulus package of $5.7 trillion in the US would be spent on infrastructure development, healthcare, education and more over next few years and create sustained demand for resources from other parts of the world. India, too, is set to grow by 9-10 percent in FY22, making it one of the fastest growing economies amid a global tide.
It is difficult to fathom a weak equity scenario given the backdrop of healthy economic growth (globally and India), ample low-cost liquidity and surging corporate profits. So, no harm in being careful in the near term but be optimistic and do not miss out on a possible multi-year rally that lies ahead for the Indian equity market.
Retail investors have shown great maturity during the volatile phase last year by showing willingness to use steep corrections to invest in equities. Time to avoid another cardinal mistake of getting carried away by small-cap mania and of chasing momentum stocks. Remain focussed on quality stocks with aim to generate healthy double-digit gains over next few years rather than quick buck in the short term.
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