Current dip in the market could be a good entry point for long-term investors

New margin rules require investors to pay half the margins in cash. This impacts standing positions as investors scramble for cash. However, brokers can finance this portion, and the cost will increase for investors to the extent of the interest charges on the financing. This has caused a short, sharp downtick in the market. But if the availability of financing is made easy, it should prove to be a good opportunity. For now, this rule’s implementation has been postponed to February.

The other reason for the sharp fall was a new Covid-19 virus stain. We believe that the fall due to this should have been contained to between 1 and 2 per cent as this is the impact on valuations of a surviving business for a quarter of cash flow loss. In case the disruption is lesser, the impact should be lesser. We continue to believe that the market levels are sustainable because while these are close to highs, valuations are significantly lower than the peak valuations seen in the pre-Covid-19 period.

In the pre-Covid-19 period, market levels were broadly maintained, indicating that the valuations then were sustaining. From those highs, the market has moved up by around 50 per cent. At the same time, earnings of FY21 over FY20 have moved up by 15 per cent, and FY22 over FY21 should deliver another 35 per cent uptick in earnings. The first two quarters of FY22 have seen earnings beat expectations, and chances of FY22 estimates being met are high. Moreover, the market discounts future earnings.

We are in the ninth month of FY22. FY23 is expected to deliver 15 per cent earnings growth and by now, the market should have priced around 10 per cent of the same if it moved in lockstep with earnings. This means against the peak valuations seen in December 2019, on earnings, we are slightly cheap. Moreover, over the same period, lending and borrowing costs, and risk-free rates have dropped by over 1 per cent. We have shown that a 1 per cent drop in interest rates increases the value of the same cash flow by around 20 per cent. Even adjusting for around 0.5 per cent yield increases on monetary policy normalisation over a period of time, we do believe that the current valuations are sustainable.

Index levels look even more sustainable if we factor in that over time, the composition of the index itself has changed to include more high-quality businesses with sustained growth.

Monetary policy normalisation is expected to not cause as large an impact as last time. Policymakers are going slow and keeping the market in the loop on decision making. In any case, the last time around, we have noticed that local events such as demonetisation, a banking crisis, and the ILFS crisis impacted our market performance more than the taper in the US. India’s 2014 election outcome saw the market respond positively. This time, we are better prepared with larger forex cover, stable currency, and low interest rates.

Outlook for the future is sustainably promising. Capex should be expected to grow. The government has been spending; but now, corporate capex and household capex should also be supportive. Households’ biggest capex is in the sector of housing. With house prices increasing at moderate levels for the past several years, house affordability has increased with an increase in wages over a period of time. Moreover, interest rates are at an all-time low, and that helps.

The Production Linked Incentive (PLI) schemes of the government across sectors are helping catalyse corporate capex. The ability of the corporates to do capex has increased with lower balance sheet stress and the buoyant market, which is further helping deleverage. Government policy reforms such as removal of retrospective taxation, Make in India, etc, have also improved sentiment. Increase in capex would help maintain growth outlook for longer, and beyond the post-Covid consumption bump-up.

While FY22 is the year of reflation after Covid, and all the focus is on growth, sustainability would come into focus in FY23. Most parts of the rich world have seen government debt increase sharply with very high fiscal deficits. The Indian situation is better. Our tax revenues are ahead of budget estimates and this has allowed the government to roll back fuel taxes, while there has been an increase in GST rates for textiles. Next year, when fiscal consolidation would be in focus, India should stand out.

The previous period saw the government lending a helping hand to the telecom sector and this period has seen players increase the tariffs to destress balance sheets and ensure survival. This is a welcome move as it ensures better quality of service for customers, better chances of 5G auctions succeeding, and prevents creation of monopolies. Lenders to stressed players would also welcome the move.

Commodity part of the market should be peaking out. Covid-19-related disruptions are easing out and logistic costs are normalising, even though another wave of the pandemic is again sweeping the West. Covid-19 slowdowns in the West may also cause prices of commodities such as oil to decline from its peaks. On Covid-19-related expected disruption; the oil prices have fallen sharply as have prices of other commodities. Oil is our largest import and so this fall definitely helps. Commodity users with pricing power have increased prices and this drop, if it sustains, should help the users of commodities with pricing power increase margins

While I continue to believe that the market levels are sustainable and any 4-5 per cent dip is a good opportunity, I do expect the market to continue to consolidate for some time on a large IPO calendar. The positive sentiment of retail investors is helping the market breadth remain good, and clearly a large IPO not doing well is a risk to sentiment. Similarly, regulatory changes can increase costs and impact in the short term, as can resurgence of any disease and resultant disruption of the economy.

At this juncture, the outlook has to be for the longer term and focus on quality of businesses is a must. Easy money has been made and utilising the services of a quality-focussed house may be better than doing it by oneself.

Happy investing.