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Pay more attention to underlying growth of the economy rather than market capitalisation

In the long-term, the ability of India to consistently grow at above 7 percent per annum would largely influence the rise in market capitalisation.

May 30, 2021 / 08:48 AM IST
The market breadth, which was extremely positive in the first half of the trading session, turned negative in the second half as the market closed below the levels of 15,670/52,100.

The market breadth, which was extremely positive in the first half of the trading session, turned negative in the second half as the market closed below the levels of 15,670/52,100.

Market capitalisation of India reaching the $3 trillion mark is a double-edged sword and investors should not read much into the milestone. On the positive side, it shows the confidence of the investors (local and global) in the growth story of India in spite of the growth bump of the second wave of COVID-19.

On the other hand, if the growth falters, investors will bring down prices as they adjust to the lower growth expectations and thus reduce market capitalisation. Sometimes if a milestone is reached on back of conflicting underpinnings, it could be well read as a sign of caution.

Market Capitalisation needs to be viewed in conjunction with aspects like relative size and more importantly, the Market Cap to GDP ratio of a country. On relative size, while India is ranked 8th in terms of global market cap at $3 trillion, USA's market capitalisation is 16x that of India at $49 trillion. The next largest economy, China, is at $12.4 trillion followed by Japan at $6.2 trillion. This shows the relative size of the markets that are backed with the size of their economies.

On the back of sustained optimism and inflow of money (local and global), India's Market Cap to GDP ratio would be currently around 1.1x while its long-term average is around 0.75x. Again, relatively, the current ratio in the USA is closer to 2x and other developed countries have a ratio of 1.4 to 1.8x and China's Market Cap to GDP ratio is at 0.71x.

While not going into a discussion if Indian markets are overvalued and if a correction is possible to bring it down to the average, it is important to understand that ultimately the growth in GDP is what will push up the market capitalisation. On the back of sustained growth and more companies listing on the exchanges, the markets will bid higher and hence push up the market capitalisation.

Close

A study has shown that India's market capitalisation has grown at a CAGR of around 18 percent in the past two decades. Assuming a conservative CAGR at 10 percent, the markets would take six years to cross the $5 trillion mark, while assuming a more optimistic CAGR at 15 percent, it would take four years to cross the mark.

Not discounting the moods and vagaries of Mr. Market that will increase or decrease the market cap, one should rather pay more attention to the underlying growth of the economy. India's ability to sustain growth post the COVID-19 second wave impact will influence the short- term movements.

At 32x, India's PE multiple is probably one of the highest and we could see a correction. While this correction would erode the market capitalization, it could well be healthy for the markets as the valuations would be re-set at reasonable levels.

However, in the long-term, the ability of India to consistently grow at above 7 percent per annum would largely influence the rise in market capitalization.

As India grows, more and more companies would need to come to the market to raise capital by getting listed and thus increase the other part of the equation. The bigger picture is surely in the continuing growth of our economy. If that comes through, India could reach $5 trillion GDP and Market Capitalization mark faster than expected.

Disclaimer: The views and investment tips expressed by investment experts on Moneycontrol.com are his own and not that of the website or its management. Moneycontrol.com advises users to check with certified experts before taking any investment decisions.
Nimish Shah is the Chief Investment Officer – Listed Investments at Waterfield Advisors.
first published: May 30, 2021 08:48 am

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