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A lot has changed for Indian equity markets in last two years. From life time high to steepest single day correction in Sensex, it has indeed been a roller coaster ride for investors.
One of the factors contributing to this ride has been FIIs' activities. While India has been a preferred destination among Asia and other emerging markets (EMs) for last few years, this is not the case anymore. As suggested in an article in Business Standard, Indian markets are losing favor. FIIs are now turning to other regional peers such as Brazil and Taiwan.
It was Modi's rise to power and expected reforms that made global funds over weight on Indian economy. India got a significant valuation premium as compared to other Asian and emerging market economies. However, weak demand and disappointment on the earnings front has led to a reality check and has sobered the investors. The most sought after market does not feature among top bets in Asia and EMs anymore.
We do not think so, provided one is investing from a long term perspective. In fact, as FIIs reduce allocations to India, the valuations are likely to be more reasonable, giving retail investors a good entry point to invest in robust quality businesses.
As far as long term fundamentals are concerned, we believe they are likely to improve for Indian economy.
My colleague Rahul Shah has already done his analysis supporting this belief. He pulled data for Nifty companies that suggests that profit margins were at a ten-year low at the end of FY15.Now even if they were to rise to the average of the last ten years, not immediately, but three years out, the upside would close to 70%.
In short, FIIs pulling out and earnings improvement in the long term could make Indian equity markets look attractive in the long term.
While this sounds easy and logical, as my colleague Tanushree Bannerjee suggested, the road to recovery is not going to be so simple for all the companies. In fact, it could be painfully long for some.
One of the biggest hindrances to earnings growth will be overcapacity in the industry. Capacity utilization as such remains one of the most important data point that Tanushree and her team are tracking. She will be cautious of businesses in sectors that are more likely to face overcapacity in the next few years and will be on the look out for the safest blue chips likely to offer the best returns over the next three years. In fact, this is exactly what she articulated in their special report, Top 5 Stocks for 2020.
To conclude, it won't be enough to count on broad earnings recovery for India Inc. Instead of tracking FII movements, retail investors would do well to focus on bottom up analysis approach before betting on specific stocks
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