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Are Indian Markets Free from Notebandi Woes?
Wed, 8 Mar Pre-Open

India's benchmark indices have had a good run over the past few days. The Sensex is at 29,000 while the Nifty is hovering around the 9,000 mark.

Both the indices reached their respective two-year highs earlier this week, signaling a departure from the notebandi blues that plagued the markets since November 2016.

However, if one looks at the big picture, the notebandi induced slowdown is a mere blip when it comes to the growth seen in the Indian share markets.

In the last 12 months, India's market capitalization has risen by a staggering 40%. This is almost double the rate (21%) at which the world market cap has grown. This sharp rise also meant that India's contribution to the world market capitalization rose to 2.5% in the past month, as compared to a long-term average of 2.4%.

The highly optimistic rally has been largely due to increased business confidence, as the notebandi move had a significantly lower impact than expected. As India's major companies brushed aside notebandi woes, investor confidence was rejuvenated as is evident from the inflow of funds from foreign investors. Majority of foreign investors had exited the Indian share markets late last year over fears about adverse impact of demonetisation. Sustained buying from domestic mutual funds also supported the rally.

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The numbers too reflect the optimism. Indian equities are trading at 17.6x estimated earnings for the 2018 fiscal. All key markets are trading at a discount to Indian equities.

However, we believe there is still some upside left. A big name global investment bank, just lifted its yearend Sensex target to 33,000, an increase of 10% over its previous estimates. It further expects the Sensex to ride to over 39,000 by the end of 2018 in a bull case scenario. Among other things, the bank lifted its earnings growth outlook. This translates to increased margins for corporate India.

This is in line with a bold prediction Rahul Shah made just about a year ago: The Sensex could rise 70% over next two to three years, taking it to 40,000.

Here's Rahul explaining his reasoning:

  • The prediction made for good headlines. But the reasoning behind it was more important than the prediction itself. Our thesis stemmed from the basic fact that, unless something goes fundamentally wrong with capitalism, profit margins tend to revert to the mean.

    If margins get too low, there won't be enough profits. Businesses shut down, competition reduces...and profitability starts to rise again.

    If margins get too high? The reverse happens. Competition enters to soak up the extra profits, capacities go up, a fight for market share ensures...and profitability starts to fall.

As corporate India bends to the principle of mean reversion...and more stock market participants wake up to the idea...our thesis is yet to play out in entirety. And it's certainly not too late for investors. You can still buy the stocks that are best positioned to ride the earnings upside to Sensex 40,000.

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Jan 18, 2018 11:03 AM