Herd mentality would come into play on a positive note

Till about ten days ago, the pessimism on the domestic equity market was at its peak –there was a dichotomy in terms of the optimism in the economy and the pessimism on the domestic equity markets partly due to herd mentality.

Almost all global institutions (like IMF, the World Bank, etc) have forecast the fastestGDP growth for India among the major economies (including Chinese economy) in the world. Still, about a week ago, theSensex corrected about 12% from its life-time high of over 30000, while the Chinese market rose nearly 150% year on year.

But in the last seven trading days, the domestic equity market emerged as the best performing market among the major global equity markets by rising by about 5%. It was partly helped by over 16% excess rainfall during the first 21 days of the current monsoon period. In contrast, the Chinese market, which was over-valued, crashed by 13% in the last one week alone.

The dichotomy between the optimism on the economy and the market within India, and the valuation gap between the Chinese and the Indian equity markets started getting corrected. Going forward, we can see these gaps narrowing down further steeply.

The Sensex earnings have fallen about 2.5% in fiscal 2015 and its average annual growth in the last four financial years is hardly around 5%. The history proves that whenever the industrial economy turns around, the Sensex earnings rebound substantially from the low base.

The benefit of cheap oil is expected to continue at least for the next two years as the Energy Information Administration of the US expects the oversupply of crude oil to continue till 2017. In fact, many international analysts predict that the oil glut could be permanent as the energy-intensity (amount of energy needed to generate a unit of GDP) of developing countries falling rapidly. For example, China’s energy intensity halved over the last 30 years. Continued cheap oil would be a major source of booster for both aggregate demand and margin expansion for the Indian industrial sector.

Of late, the inflows through Foreign Direct Investments (FDIs) have become very robust – it grew at 27% yoy in fiscal 2015, and in April 2015 it shot up by over 100%. Current inflows account for almost 2% of India’s GDP which can push GDP growth (mainly within the industrial sector) at least 50 bps (= 2% ÷ 4.3) at the current rate of Incremental Capital Output Ratio of 4.3.

These three key facts along with government’s major initiatives on developmental efforts would spur herd mentality on a positive note for the markets in the short term itself.


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