‘Positive’ election outcome could lead to market re-rating - Livemint
The stock markets are slowly rising in anticipation of the outcome of the ongoing general elections. The Bharatiya Janata Party (BJP)-led National Democratic Alliance is widely expected to form the next government. However, markets have not made big a upmove yet and are probably waiting for the results to be declared. In an interview, Harshad Patwardhan, executive director and head of equities, JP Morgan Asset Management India Pvt. Ltd, shares his thoughts on the present situation in the markets and what he expects in terms of market movement with regards to the possible election verdict. Edited excerpts:
Recent data that showed inflation was up and industrial production down, but markets are still moving up. Is there a disconnect between markets and fundamentals?
I don't think so. The fact that we are in a situation of high inflation and low growth is well known. It's not a new phenomenon. Clearly, market is looking at what lies ahead. What lies ahead is that cyclical growth seems to be picking up in India. If you look at the estimates for gross domestic product growth, for example, most economists are forecasting FY15 growth to be higher than FY14 growth. And this has nothing to with the elections. The change of direction is important. After almost seven quarters of sub-5% growth, there is a prospect that over the next year or year-and-a-half, the growth will accelerate to above 5%. This is what the market is focusing on.
If you look at the Sensex earning per share growth between FY08 and FY13, it has been about 7.5% compounded, which is very low compared to the historical growth of 15-16%. From this very low level of activity, the economy is expected to pick up.
In addition to that, there is the element of elections. So I don't think we should look at these two factors (IIP and inflation) and say there is a disconnect. There are other factors as well.
Everybody is talking about elections and seems to be playing the momentum. Have markets moved ahead of fundamentals?
Even if we have a favourable outcome in the elections, many things that are ailing the economy are not going to disappear overnight. It will be a long grind because whatever has happened over the past few years in terms of under-investment in infrastructure, in corporate investments, and low business confidence, will take time to change.
But there are many phases in the market when it runs ahead of fundamentals. If you analyse the behaviour of equity markets, there are essentially three factors behind it. One is underlying earning progression, second is valuation and third is dividends, which go into total market returns. Let's leave aside dividends. But if you look at the other two factors, many times we have seen the big changes in the market can be explained by re-rating or de-rating before earnings catch up. At the time of the global financial crisis, in terms of changes in earning progression and in valuations, the latter dominated. So the market was de-rated significantly and earnings changes happened with a lag. Similarly, when the rally began in 2009, it can again be explained largely by significant re-rating. Earnings trajectory started becoming positive and strong only with a lag. So the market often runs ahead of fundamentals and if you wait for it to become favourable, markets would have already gone up a lot.
If we have a good government, whatever steps it might take, the effect on economic parameters will be felt maybe 12-18 months later. But markets are not going to wait for fundamentals to improve. Market returns may be front-ended as the factor which will be operative is the re-rating.
Has that re-rating happened?
It has not happen yet. If we have a positive election outcome (in-line with the opinion polls), I would expect the re-rating to being then. Right now, there is a lot excitement; there is a lot of noise about the election outcome. But if you go by the cold numbers, market (Sensex) is trading at about 14.1 times one-year forward (earnings). To put it into perspective, the long-term trading average is 14.6. So, if there was euphoria, it is not showing in the numbers, which means there is excitement and talk but is not reflected in the Sensex price-earnings ratio. If the election outcome is positive, the market could get re-rated.
What would that re-rating mean for the market in terms of levels?
It is very hard to say as it will depend on the weight of the money. Now let us say that there is a positive outcome in the elections that is in-line with the opinion polls and the market re-rates to one standard deviation above the mean. Currently, the mean is 14.6 and standard deviation is about 2.4, so the market re-rates to 17 times one-year forward (earnings) compared to 14.1 now. If you want to forecast where the market could be a year from now, let us say that market valuation changes from 14.1 to 17 times one-year forward. In the interim, earnings will also grow at about 15%. If you combine the two, the returns, in case of a positive election outcome, could be 39-40%.
What is important from an asset allocation perspective is that even if the outcome is not in-line with the opinion polls... i.e., even if the BJP does not get as many seats as is forecasted and the prime ministerial candidate is somebody else. And due to this, let us say, the market de-rates from 14.1 to 12.2, which is one standard deviation below the mean, in that case, you have a de-rating of the market but you still have the cyclical growth happening in the economy anyway. The net result of de-rating and the underlying earnings progression is that in scenario two, you have a market that's probably flat a year from now. It's a good risk-reward to have.
Source >>Livemint
Thanking you
Regards,
Rajesh Kumar Kathpalia ¤ SMC Global
17,Netaji Subhash Marg,Daryaganj,
New Delhi-110002 Mobile No 9891645052
Email Id: rajesh.ipo@smcindiaonline.com
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Recent data that showed inflation was up and industrial production down, but markets are still moving up. Is there a disconnect between markets and fundamentals?
I don't think so. The fact that we are in a situation of high inflation and low growth is well known. It's not a new phenomenon. Clearly, market is looking at what lies ahead. What lies ahead is that cyclical growth seems to be picking up in India. If you look at the estimates for gross domestic product growth, for example, most economists are forecasting FY15 growth to be higher than FY14 growth. And this has nothing to with the elections. The change of direction is important. After almost seven quarters of sub-5% growth, there is a prospect that over the next year or year-and-a-half, the growth will accelerate to above 5%. This is what the market is focusing on.
If you look at the Sensex earning per share growth between FY08 and FY13, it has been about 7.5% compounded, which is very low compared to the historical growth of 15-16%. From this very low level of activity, the economy is expected to pick up.
In addition to that, there is the element of elections. So I don't think we should look at these two factors (IIP and inflation) and say there is a disconnect. There are other factors as well.
Everybody is talking about elections and seems to be playing the momentum. Have markets moved ahead of fundamentals?
Even if we have a favourable outcome in the elections, many things that are ailing the economy are not going to disappear overnight. It will be a long grind because whatever has happened over the past few years in terms of under-investment in infrastructure, in corporate investments, and low business confidence, will take time to change.
But there are many phases in the market when it runs ahead of fundamentals. If you analyse the behaviour of equity markets, there are essentially three factors behind it. One is underlying earning progression, second is valuation and third is dividends, which go into total market returns. Let's leave aside dividends. But if you look at the other two factors, many times we have seen the big changes in the market can be explained by re-rating or de-rating before earnings catch up. At the time of the global financial crisis, in terms of changes in earning progression and in valuations, the latter dominated. So the market was de-rated significantly and earnings changes happened with a lag. Similarly, when the rally began in 2009, it can again be explained largely by significant re-rating. Earnings trajectory started becoming positive and strong only with a lag. So the market often runs ahead of fundamentals and if you wait for it to become favourable, markets would have already gone up a lot.
If we have a good government, whatever steps it might take, the effect on economic parameters will be felt maybe 12-18 months later. But markets are not going to wait for fundamentals to improve. Market returns may be front-ended as the factor which will be operative is the re-rating.
Has that re-rating happened?
It has not happen yet. If we have a positive election outcome (in-line with the opinion polls), I would expect the re-rating to being then. Right now, there is a lot excitement; there is a lot of noise about the election outcome. But if you go by the cold numbers, market (Sensex) is trading at about 14.1 times one-year forward (earnings). To put it into perspective, the long-term trading average is 14.6. So, if there was euphoria, it is not showing in the numbers, which means there is excitement and talk but is not reflected in the Sensex price-earnings ratio. If the election outcome is positive, the market could get re-rated.
What would that re-rating mean for the market in terms of levels?
It is very hard to say as it will depend on the weight of the money. Now let us say that there is a positive outcome in the elections that is in-line with the opinion polls and the market re-rates to one standard deviation above the mean. Currently, the mean is 14.6 and standard deviation is about 2.4, so the market re-rates to 17 times one-year forward (earnings) compared to 14.1 now. If you want to forecast where the market could be a year from now, let us say that market valuation changes from 14.1 to 17 times one-year forward. In the interim, earnings will also grow at about 15%. If you combine the two, the returns, in case of a positive election outcome, could be 39-40%.
What is important from an asset allocation perspective is that even if the outcome is not in-line with the opinion polls... i.e., even if the BJP does not get as many seats as is forecasted and the prime ministerial candidate is somebody else. And due to this, let us say, the market de-rates from 14.1 to 12.2, which is one standard deviation below the mean, in that case, you have a de-rating of the market but you still have the cyclical growth happening in the economy anyway. The net result of de-rating and the underlying earnings progression is that in scenario two, you have a market that's probably flat a year from now. It's a good risk-reward to have.
Source >>Livemint
Thanking you
Regards,
Rajesh Kumar Kathpalia ¤ SMC Global
17,Netaji Subhash Marg,Daryaganj,
New Delhi-110002 Mobile No 9891645052
Email Id: rajesh.ipo@smcindiaonline.com
--
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To unsubscribe from this group and stop receiving emails from it, send an email to Productupdatesforamc+unsubscribe@googlegroups.com.
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