The medium-to-long-term prospects of Indian equities are exciting. But the market never moves in a straight line and corrections are a healthy part of any bull market. So it is not very useful to try and predict market movements over 6-12 months. Indian equity markets were up by 19 per cent in the financial year 2017 in spite of 10-11 per cent correction witnessed in the September-December quarter.
Markets in the short term are all about sentiment and flows, and these have supported the recent rally. We are also seeing a reduction in India's risk premium due to a steady improvement in macro fundamentals and the structural reforms carried out by the government. This is helping the medium-term bull case for both equities and bonds. With the economy set to turn around, the same should be reflected in corporate earnings.
The outlook can be split into policy-driven structural changes and cyclical changes in the economy. The structural changes, including the Goods and Services Tax (GST), are growth positive in the long term. The government is also avoiding short-term populist steps. Demonetisation was a part of that thinking.
The combination of Jan Dhan, Aadhaar and digital payment infrastructure may also witness a transformation in how India transacts. Incidentally, cash presents a dual cost to the economy. The first is an inefficiency cost and the other encourages the informal economy. With the transformation in financial inclusion and payment mechanism, we should see a big move towards formalisation.
The government has also been prudent in the fiscal department. Lower fiscal deficit, combined with low current account deficit, has led to a sharp reduction in India's risk premiums. This is causing a big jump in foreign portfolio investment flows besides strengthening the rupee. Foreign institutional investors pumped Rs 55,703 crore into domestic equities during the financial year ended March 31, 2017, against a net outflow of Rs 14,172 crore in the year before. This will help create a virtuous cycle of low inflation and low interest rates. If inflation is contained to 4 per cent, yields can drop materially.
On the cyclical economy front, things have been a bit patchy. Consumer demand has been hit by weak jobs and wages growth, but has been supported by a good monsoon, low inflation and low interest rates. Industrial capex has been comatose given private sector balance sheet challenges, but the government has tried to push investments in infrastructure.
We are at the cusp of a recovery in the earnings cycle. Broader market earnings should improve slowly over the next few quarters although GST rollout and the risk of shorter-term disruption make it difficult to give a specific road map on earnings. The earnings season for the third quarter showed mixed results. Now that companies have started reporting March quarter results, things will become clearer.
With the overall markets being fairly valued, returns will be a function of the companies and sectors which are able to deliver consistent growth. We remain bullish on equities from a medium-to-long-term perspective. Long-term investors (both debt and equity) should not worry about potential short-term market volatility, and invest to participate in this story. Investors need to focus on the long term while making allocations in order to get the best outcomes from their investments. They should not be bothered by short-term market movements and instead, should focus on their goals and make appropriate investment decisions.
By, CHANDRESH NIGAM, CEO and MD, Axis Mutual Fund