The Bull Market in developed markets like the US, Germany and UK have been now on for the last 5 years. Most developed markets have doubled or more from the bottoms of 2009. However in the case of most Emerging Markets we have seen turbulent periods over the entire 2009 to 2013 period where we have had good years like 2009 and 2010 followed by an extremely tough 2011, a good 2012 and an average 2013. So it is difficult to say when the bull market started in EM’s. However for India it has actually started this year as the driver of the markets over the years previous to 2014 were either defensive stocks or stocks that derive growth from overseas markets i.e. IT and Pharmaceuticals.
First let’s look at the global perspective. To me it is very clear that the global bull market cannot end when major economies have zero interest rates. Today we have a scenario where the overnight rates are zero in US, UK, Euro zone and Japan. The first expected increase is likely from the US that too 15-18 months down the line. Euro zone is still grappling with deflationary fears and unlikely to increase rates in the foreseeable future and same is the case with Japan. When the US FED decided to wind down Quantitative Easing there was lot of fear in the markets. At that time, in my article “Do Not fear FED TAPERING for the right reasons” I had clearly pointed out that the fears were baseless and if growth revival and not inflationary spiral is the cause of Tapering then it will be good for the markets. It played out exactly that way.
Now comes the question at what level of FED FUNDS rate should we start getting worried. My guess is that till the time the overnight rate in the US reaches a level of 3% and the US 10 year bond yield a level of 4-4.5% the bull market in Equities will continue. I will not elaborate but explain in brief. Firstly rates will go up as the US FED becomes more comfortable with the growth outlook i.e. possibility of stronger growth. Stronger growth is good for the Equity Markets. The second factor then is that at what level of interest rates will growth prospects start looking dimmer. That should be around 200 basis points above the current US 10 yr bond yields of 2.5%. At that stage depending on the stance of the ECB, Bank of Japan and other central banks we will need to take a call on the direction of the markets. However this is still 3 years down the road.
Looking specifically at the Indian perspective my view is that the Bull Market actually started after the massacre of the small and mid cap stocks was over. Small and Mid caps got smashed in 2008, Whacked in 2011 and finally destroyed in the year 2013. This was the time when people lost total hope in equities in India and redemptions from domestic MF’s reached a crescendo. The outflow from equities in general and a shift into other assets like gold, tax free bonds, real estate etc also reached a peak at this stage.
Most people tend to believe that as interest rates in the US move up they will move up in India too. This is not necessarily true. The difference between the 10 yr bond yields in India and US has swung between as low as 0.5% to as high as 6.5% over the last 10 years. Fiscal Prudence combined with lower inflation can create a situation where Indian interest rates can actually decline even as they increase in the developed markets.
Several factors led to a stagflationary scenario in the Indian economy. It started with the commodity spiral boosted due to easy money policies of Western Central banks, which in combination with Fiscal Profligacy let to high inflation and interest rates. This got combined with a governance deficit of the previous UPA government and led to a collapse of growth from 9% three years back to just 4.5% in 2013. Inflation is now on the way down and the new government is focussed on growth revival along with inflation control by a combination of Fiscal constraint and a boost to the supply side. These factors are positive for growth revival.
The growth revival cycle in India is just starting. We saw a bottoming of growth at 4.5% last year. This should swing back to 6% this year and between 7-8% over the following 3 years. Stock markets will always do well in the period of accelerating growth. . Every economy goes through phases of profit expansion and compression while the GDP and the Turnover (sales) of companies continue to grow. The phases of profit expansion take the profits more than the growth in sales. As profits grow more than the turnover of the companies, in general the Return on Networth or the Return in Capital also move up. This leads to an upward rerating of the companies in that economy as the outlook for future growth looks positive. During this phase the Market capitalization to GDP ratio of that stock market expands
India’s market capitalization to GDP reached a level of 60% last year. This level currently stands at 85%. The case for expansion in India’s Market Cap to GDP going forward is extremely strong. The ratio moved up from 45% in 2003 to 160% by the end of 2007 in the case of India. If the ratio moves back to a level of 120% over the next five years and in the same time period we have a nominal GDP growth of 11-12%. The calculation reveals a 125-150% return potential in this scenario over the next 5 years. Basically NIFTY above 18000 and SENSEX above 60000. As such wealth creation in the Indian Markets over the next 3-5 years could be huge due to a combination of a stronger growth in profitability as well as a rerating of the economy i.e. expansion of Market Cap to GDP in the same time period.