The best time to make money in the stock market is when the economy is accelerating. We may be getting into that phase. Most research houses have started upgrading their GDP growth forecast for the coming financial years.
“We have upgraded India’s GDP growth forecast from 5% year on year to 6% in 2014-15 and from 6.5% to 6.8% in 2015-16,” says Sonal Varma, executive director and India economist, Nomura. According to Bloomberg, India’s GDP is expected to grow 5.4% in 2014-15, 6.2% in 2015-16 and 6.6% in 2016-17.
MANUFACTURING REVIVAL: Greenshoots are visible in the manufacturing sector. This is what triggered GDP growth in the first quarter of 2014-15. “The base effect was the main reason for this pickup in manufacturing in the first quarter,” says Indranil Sengupta, India economist, BofA-ML. Last year (2013-14), manufacturing growth was quite poor, this base effect is expected to continue for the entire year. Industrial production growth may hit double digits towards the end of this fiscal year, say experts.
Efforts by the government to revive manufacturing have also helped improve sentiment. Prime Minister Narendra Modi’s ‘Make in India’ call, inviting global firms to manufacture in India, in addition to the government’s efforts in resolving issues holding up projects, should help to revive the sector.
INVESTMENT CYCLE REVIVAL: The government is intent on unclogging the investment pipeline—the starting point for the revival of the investment cycle. It is keen on speedy acquisition of land, faster environment clearances and removal of bottlenecks in financial closure.
The second phase of the investment cycle revival will begin when companies start hitting their capacity limits due to increased manufacturing and are forced to undertake fresh capital expenditures.
FALL IN INFLATION: Consumer price index (CPI) has fallen below the 8% target set by the Reserve Bank of India (RBI) for January 2015 (see chart: India CPI), despite a weak monsoon pushing up food inflation.
Also, “The announced increase in the minimum support price for agricultural products is small, so it won’t stoke inflation,” says V Balasubramanian, fund manager and head, equity, IDBI MF. Fall in international crude oil prices is the main reason behind the fall in CPI.
Fall in crude oil prices will also bring down our import bill, reduce fiscal deficit, and help cut government subsidy. The fear of interest rate hikes by US Federal Reserve is pulling the crude now. But a rate hike may not necessarily affect the rupee and thus not spike inflation.
“We have enough forex reserves to take care of the currency volatility when US Fed increases the rates,” says Balasubramanian. Fall in inflation helps push growth in several other ways. The ‘real GDP growth’ is arrived at by deducting inflation from the ‘nominal GDP growth’ and, therefore, the reported GDP growth rates are higher during low-inflation periods. Then, low inflation leaves more money in the hands of the consumer to spend and helps revive consumption growth.
Finally, low inflation allows the RBI to cut interest rates, further boosting consumption and industrial growth. “Inflation is expected to come down to 6.9% by end-2014-15. RBI may start cutting rates from February 2015, if there is no shock on the oil and currency front,” says Sengupta. We may be getting into a multi-year virtuous cycle of high growth and low inflation.
How to play the revival
Reflecting the mood, research houses have started increasing their one-year Sensex targets. For instance, Nomura’s one-year forward (August 2015) is 30,310 —up 15% from current levels. If the expected revival happens, economy related sectors are expected to generate much better returns.
INFRASTRUCTURE: The government is making efforts to revive this sector. The foreign direct investment (FDI) cap in defence has been increased from 26% to 49%; government has also allowed 100% FDI through automatic route in the rail infrastructure sector. India’s annual infrastructure sector growth hit a nine-month high of 7.3% in June compared to a 2.3% growth in May.
However, investors should not rush in. Most infra companies listed in India are plagued by very high debt and have corporate governance issues. The recent Supreme Court ruling stating that the 200 coal block allocations, since 1993, were not done in a transparent manner and are illegal, is a major setback to coal-dependent sectors such as metals, cement and power.
A possible de-allocation will risk investments—estimated to be around Rs 3 lakh crore. “It is too early to assess the exact impact because the Supreme Court is going to hear the case from September 1 again,” says Balasubramanian.
Also, because of the sudden jump in prices in the past one year, most infrastructure stocks are not cheap anymore. However, there are some you can still bet on. Larsen & Toubro is the best among the lot. The firm has a strong balance sheet, strong order book, clear earnings visibility and diversification in terms of geography and also segments. If you follow the ‘high risk-high return strategy’, GVK Power and Infra is the best stock for you in the midcap infra space.
“Though tied down by high debt, GVK Infra has a good management and strong corporate governance. As the stock is trading at distressed valuation with a market cap of around Rs 2,000 crore, investors with an appetite to take risk on their capital can consider investing in this stock,” says Nitin Jain, president, Edelweiss Broking. Stocks from the logistics sector should also benefit from the economic recovery.
FINANCE: Banking and financial services stocks usually benefit from an economic upturn. During a revival, demand for consumer loans and housing finance goes up because of better remunerations to the service class.
Also, revival in the capex cycle increases the demand for corporate loans. Access to loans helps inject new life into struggling firms, helping repay new and old loans, thereby, reducing the bad debt problems of the finance industry. Then, fall in inflation and interest rates helps finance firms book treasury gains.
Though one should expect a similar trend this time also, the uncertainty created by the Supreme Court ruling on the coal scam has shadowed its prospects. Indian financial services firms are estimated to have a Rs 5 lakh-crore exposure to the power sector. De-allocation of coal blocks will impact infrastructure finance organisations such as IDFC, PFC, REC, and also large public sector banks such as the State Bank of India.
With the finance minister stating that public sector banks need to raise funds from the market and not wait for government support, their capital raising plans have also come under the cloud. “New-generation private sector banks are better prepared to benefit from the economic recovery because they are well capitalised,” says Balasubramanian.
Housing finance, as a segment, should do well because it is not affected by the coal shock. Though currently valued at 3.7-times its book, Repco Home Finance is growing very fast and can be a multi-bagger.
OIL & GAS: Stocks from oil and gas space, especially the public sector companies who reel under the oil subsidy burden now, are going to benefit due to the fall in international crude prices. Their under-recovery has fallen below Re 1 due to the recent fall. The diesel decontrol can happen in less than two months, if international crude oil prices and the rupee remains stable.
There are other factors you need to look at as well. BPCL is a good pick because of its highly valued upstream assets. In addition to the fall in subsidy burden, the expected hike in natural gas prices stands to benefit ONGC.
“Though the new government may not allow $8.4 per mmbtu, price is expected to be significantly higher than the current level,” says Prayesh Jain, AVP, research, IIFL.