A report on ‘Why to invest in Indian equities in 2021?

’
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Equity Market: Introduction

Equity market, often called as stock market or share market, is a place where shares of companies
or entities are traded. The market allows sellers and buyers to deal in equity or shares in the same
platform.

Equities are mostly traded on the stock exchanges in India. In the Indian stock market, equities are
available for trading at the National Stock Exchange (NSE), the Bombay Stock Exchange (BSE)
and the latest entrant, Metropolitan Stock Exchange of India (MSE). Shares of stock market listed
companies are bought/sold.

Equity share trading is roughly in two forms - spot/cash market and futures market. These are the
different types of equity market in India. The spot market or cash market is a public financial
market in which stocks are traded for immediate delivery. The futures market is a place where the
shares' delivery is due at a later date.

Factors in support of Indian Equity Market

1. Policies of the RBI

The Reserve Bank of India is helping to fan a world-beating share market rally with record-low
interest rates and huge injections of liquidity.

RBI Governor Shaktikanta Das has said the central bank is in “whatever it takes mode" to
support the economy.

The RBI’s main repurchase rate is at an all-time low of 4%, the government is committed to high
spending and data from Bloomberg Economics show excess liquidity in the banking system this
month touched a record 8.6 trillion rupees ($115 billion).

2. Foreign Portfolio Investments

With the onset on the Covid-19 Pandemic in 2020, according to data from Bloomberg and NSDL,
India’s equity markets saw an FPI outflow of $8.3 billion. From May to August, FPIs remained
buyers in the Indian markets, pumping in $11.4 billion in total.

At a net inflow of $3.07 billion between March and October, Indian markets were better placed
than most emerging equity markets. For example, countries such as Thailand, Brazil, Taiwan and
South Korea saw outflows of between $7.7 billion and $20.1 billion from March till October. India
remained the only emerging market in Asia besides China to see FPI inflows for the calendar year
2020.

In 2021, overseas funds have poured $7.2 trillion into the nation’s equities and net inflows are
expected to continue.

3. IPO Market

An article, written by RBI deputy governor Michael Debabrata Patra earlier this month, read

“The year 2021 could turn out to be India's year of IPO with the domestic unicorns through their
public issues setting “domestic stock markets on fire and global investors in a frenzy.” The Initial
Public Offerings by new age companies in the recent months are a reflection of bullishness about
Indian technology and growth impulse is igniting financial markets. It also talked about Zomato’s
IPO being oversubscribed 38 times and the 2.2 bn dollar proposed listing of PayTM. It is estimated
that India has 100 unicorns with 10 new ones created in 2019, 13 in 2020 in spite of the pandemic
and 3 a month in 2021 so far.”

4. Domestic Investors

Domestic institutions are also piling in, along with retail traders, contributing to a record $3 billion
that funneled into equity funds in July 2021. While India has suffered a staggering toll from the
coronavirus, individual investors by the millions are rushing into stock trading with savings built
up during lockdown.

5. Market Performance

The benchmark S&P BSE Sensex has more than doubled from its Covid-induced nadir in March
last year, with gains accelerating this month as it continues to extend record highs. The rally has
made it the world’s best performer in August among primary indices of nations with an equity
market capitalization of at least $3 trillion.

6. Government Policies and Budget

When the Union Budget 2021 was announces by Finance Minister Nirmala Sitharaman, the
benchmark indices Sensex and Nifty closed 5% higher, as market participants reacted positively
the Union Budget 2021. BSE benchmark index S&P Sensex, ended 2,314 points higher at 48,600
and NSE Nifty 50 index gained 646 points to 14,281. This was once in a life time jump seen on
budget day. Almost all the sectors traded in green territory, rising in the range of 3-6%.

To give a better understanding of the significance of this reaction, budget 2020 had failed to cheer
the Dalal street as the market witnessed its biggest fall on February 1 since 2009. On last year's
budget announcement, Sensex had crashed 2.43% and closed right below 40K, as investors lost
around Rs 3.6 lakh crore of wealth on BSE.

Impact of Government Policies on Stock Market:

Monetary Policy:

Reserve Bank of India (RBI) is the apex body which regulates the monetary policy in India. RBI
keeps on reviewing its monitory policy. Any increase or decrease in Repo and Reverse Repo rates
impacts the stock prices. If RBI raises key rates, it reduces the liquidity in the banks. This makes
borrowing costlier for them and in turn, they increase the lending rates. Ultimately, this makes
borrowing highly expensive for the business community and may find it difficult to service their
debt.
Investors see it as a barrier in the expansion of business activities and start selling the shares of the
company which reduces its stock price. A reverse of this happens when RBI follows a dovish
monetary policy. Banks reduces the lending rates which leads to credit expansion. Investors
consider it as a positive step and stock price starts improving.

Inflation:

Inflation is a surge in the pricing of goods and services over a period of time. High inflation
discourages investment and long-term economic growth. The listed companies in the stock market
may postpone their investment and halt production, leading to negative economic growth. The fall
in the value of money could also lead to a fall in the value of savings. The stocks of luxurious
companies also tend to suffer as nobody will want to invest in them. This not only adversely affects
one's purchasing power but also the investing power.
The scenario of India:

Every two months, The RBI evaluates the outlook on economic growth and inflation. For inflation,
it has a well laid out target — maintaining retail inflation at 4% with a leeway of 2 percentage
points on either side. In other words, retail inflation can vary between 2% and 6% without the RBI
needing to explain to the Parliament. On growth, there is no specific target. In fact, RBI cannot
actually “target” a particular level of GDP growth. All it can do is to “prioritize” supporting growth
as against containing inflation.

Since late 2018, the RBI has been prioritizing supporting growth over curbing inflation. This
strategy involved signaling a cut in the interest rates prevailing in the economy; the RBI does this
by cutting the repo rate as talked about earlier. This was a really good news for the stock market
because people will invest at a time like this. This strategy was possible because retail inflation
had been well within the RBI’s comfort zone.

But since late 2019, retail inflation has been either almost 6% or more. This, in turn, incapacitated
the RBI to cut interest rates further — even when a Covid-induced “technical” recession demanded
the RBI to do whatever it could. This is because if they would cut interest rates further, the inflation
would increase too much. Unable to cut rates itself, the RBI did the next best thing: Flood the
market with lots of money (often referred to as liquidity). It hoped that this would enable borrowers
— be it small businesses or large companies or indeed the Government of India — to raise funds
at a time when most revenue sources had dried up. This move also impacts the stock market in a
positive way.

But this influx of liquidity also leads to inflation. The concern here is that this price rise is
happening when the overall demand in the economy is still quite depressed; as and when demand
picks up, inflation will likely rise further. If inflation does not come down, the RBI will be forced
to raise interest rates either by December 2021 or February 2022 policy reviews. This will
negatively affect the stock market.

Global investor sentiment towards India

India emerged as the biggest recipient of foreign portfolio investments in FY 20-21 with net
inflows worth Rs 2.6 lakh crore, driven by ample liquidity in global markets and hopes of faster
economic recovery, according to experts.
Investments in the equities segment touched Rs 2,74,503 crore, which is the highest quantum
of money recorded ever since the National Securities Depository Ltd began making FPI data
publicly available.

Previously, the highest inflow of Rs 1.4 lakh crore into the equities space was witnessed in the
financial year 2012-13.

V K Vijay Kumar, Chief Investment Strategist at Geojit Financial Services, said financial
sector, mortgage lenders, fintech companies and private insurance players, attracted significant
FPI inflows.

Going forward, he said that IT, financials, cement and pharma have high earnings visibility,
and therefore might attract increasing FPI inflows in FY22.

In 2020-21, foreign portfolio investors have put in a net sum of Rs 2.74 lakh crore into equities
and pulled out a total amount of Rs 24,070 crore from the debt segment while hybrid instruments
saw an inflow of Rs 10,238 crore, as per data available with the depositories.

Together, the total net FPI inflow this fiscal was Rs 2.6 lakh crore as on March 30, 2021.
Between March 2020-March 2021, foreign portfolio investors have been net buyers in all
months except March, April, May and September 2020.

"The massive fiscal stimulus by governments and monetary stimulus by central banks has led
to inflows into select emerging markets. India has been the biggest recipient of FPI flows in
FY21 amongst emerging markets because of the stronger recovery in the economy and surprise
in earnings growth," Rusmik Oza, Executive Vice President and Head of Fundamental Research
at Kotak Securities, said.

Further, India witnessed an addition of more than USD 100 billion to its forex reserves which
helped Indian rupee to remain steady against the dollar and other currencies.

In FY 19-20, foreign portfolio investors were net sellers as they had pulled out Rs 27,528 crore.
Despite pandemic woes and concerns over the economy, domestic stock markets performed in
20-21, giving substantial returns to investors.
Himanshu Srivastava, Associate Director - Manager Research at Morningstar India, said there
was a gush of foreign investments into Indian equities after the US presidential elections, which
has continued unabated.

Availability of excess liquidity in the global markets and low interest rates that diverted foreign
flows into emerging markets like India were among the other factors that ensured sustainability
of the investment flows, he noted.

Immediately after March 2020, when the scale of the pandemic was realized, the markets saw
major corrections and the general expectation was that the world economy would take long time
to recover, in response to which, the western economies and primarily the US printed money
aggressively to stimulate their economies, Harsh Jain, Co-Founder and COO at Groww, said.

Massive amounts of money flowed into India and helped the markets recover. This massive
inflow, however, has not been seen in other emerging markets, he said, adding that this clearly
signals that foreign portfolio investors expected India's economic recovery to be much sharper
and faster than other emerging economies.

The Q1 FY 2022 quarterly results were weak, impacted by the disruption of business activities due
to the second wave of COVID-19. However, earnings are expected to recover from Q2 onwards,
which will be largely driven by re-opening trade as well as pre-festive buying starting from early
September. Beyond the Q1 blip, earnings momentum is expected to remain resilient supported by
a strong recovery in the second half of the fiscal year. Post the June quarter results, FY 2023
consensus EPS continues to remain largely unchanged.

In terms of equity flows, FPIs have again turned net buyers of Indian equities in August so far with
net inflows of USD 870 m, after being net sellers in July. FPIs will likely not desert Indian equities
as India’s structural outlook has improved materially, and it offers one of the fastest growths
among major economies. On the other hand, the domestic mutual funds recorded the fifth
consecutive month of inflows as investors remained optimistic about the Indian equity market.

While near-term indicators are looking a little stretched for equities, the medium-term outlook for
Indian equities remains attractive. In terms of asset allocation, equity can still offer attractive
returns compared to bonds as per Credit Suisse’ global Investment Committee. They recommend
investors cut beta of their portfolio especially by bringing down the exposure to the mid-caps and
small caps while increasing exposure to large caps and also expect some minor underperformance
by Indian equities given stretched valuation. Nevertheless, Indian equities will continue to
command better valuation premium compared to EM peers.

Valuation of Indian Equity Markets

The S&P BSE Sensex and Nifty50 logged their best financial year performance in a decade and
surged 68 per cent and 71 per cent, respectively in FY21. Earlier during FY10, the S&P BSE
Sensex had surged 80.5 per cent, while the Nifty50 rallied 73.7 per cent. Meanwhile, foreign
holding in the Indian equity market has shot up to 27.6 per cent, much above the long-term average
of 19.6 per cent, a recent Nomura report said. FII’s increased their holding in metals, cement,
coal/utilities, consumer durables and industrial sectors in the last few months, while cutting their
position in media and real estate sectors.

The stock market capitalization-to-GDP ratio is a ratio used to determine whether an overall market
is undervalued or overvalued compared to a historical average. It is calculated by dividing the
stock market cap by gross domestic product (GDP). The stock market capitalization-to-GDP ratio
is also known as the Buffett Indicator—after investor Warren Buffett, who popularized its use.
This may not be a fit-for-all indicator. In the US, the m-cap-to-GDP ratio has hit 200 per cent and
in Taiwan, it is screaming at 300 per cent currently.

India's market capitalization-to-GDP ratio is hovering above 100 per cent level, ringing alarms
over expensive valuations. But do not get surprised if the same, called Buffett Indicator because
the legendary investor uses it to judge pricey markets, one day touches 200 per cent for Dalal
Street.

Growing steadily over the past 15 years, barring the 2010 jump to 97 percent, India’s market
capitalization to GDP ratio has fluctuated around the 70 percent mark. During this time, both the
economy as well as the markets have grown steadily, at their own paces. At 112 percent today,
this ratio is the highest ever. Against the world average of 129 percent, this number is lower than
the US (222 percent), Canada (180 percent), South Korea (136 percent), Japan (133 percent) and
the UK (131 percent). But it is higher than China’s 79 percent.

Of course, all these markets have hit their highs over the past year. At 85 percent, the absolute (not
adjusted for currency) 12-month returns from India are the world’s highest, followed by South
Korea (81 percent), Canada (63 percent), the US (51 percent), the UK (48 percent) and Germany
(46 percent). But you don’t assess or analyze a market based on such short-term movements. Over
the past two decades, the market capitalization of Indian markets has increased at a compounded
annual growth rate of 18.2 percent.

Second, point to point returns. Over the past 30 years, the Sensex has risen from less than 1,000 to
more than 50,000, a CAGR of 14.9 percent. The number is 13.4 percent for the past 20 years, 11.9
percent over the past 10 years, and 14.6 percent over the past five years. These returns are among
the highest in markets that have a current capitalization of more than US $2 trillion. A liquidity
surplus is pushing stock price values higher globally. In India, it is being accentuated by domestic
investors that have been investing in equity mutual funds.

Third, with the rise in stock prices and market capitalizations comes a commensurate increase in
valuations, leading some analysts to say that the Indian market, like several others, is overvalued.
At 31 times, India’s price to earnings multiple is among the highest. A one-time high is not the
problem; a sustained high PE multiple could be. But the high PE multiple today is possibly
factoring in the past track record of economic growth and the expectations of growth to continue
into the future. As a result, the country, and through it, the underlying companies that are growing
faster than the economy, gets a premium. This could change overnight, of course.

And fourth, a large base of consumers and a high scale of industrial and services activity combined
with a rising entrepreneurial zeal does wonders. Is Indian business at that take-off point? We
cannot be sure—a US $2.7 trillion economy, the world’s fifth largest after the US, China, Japan
and Germany, India is expected to be the world’s third-largest economy within this decade. This
GDP will ride companies. The US $3 trillion market capitalization of Indian companies shows the
scale of its institutionalization with a larger number of direct investors and through intermediaries
such as mutual funds, insurance and even provident funds entering it.

After a sharp run up from their March 2020 low, the valuation of Indian stock market has become
a concern now, HSBC said in their Asian outlook conference for the second half of 2021. It
maintains a ‘neutral’ rating on Indian equities, but expects foreign direct investment (FDI) to pick
up pace going ahead as the economic recovery gathers steam.
Most emerging markets (EMs) witnessed healthy flows for most part of FY21 as global central
banks, especially the US Federal Reserve (US Fed), remained ‘accommodative’ and pushed
liquidity to help revive economic growth. In this backdrop, foreign portfolio investors (FPI)
invested across geographies and asset classes. India, too, got its share with FPIs investing a record
Rs 2.74 trillion ($37 billion) during FY21 in the Indian markets – the most since FY13, when they
had pumped in Rs 1.4 trillion ($25.8 billion), data show.

Indian markets, according to Herald van der Linde, head of equity strategy for Asia Pacific at
HSBC, are seen as an alternative to China. “Flows to China are usually fed out of India and vice
versa. That said, the valuation of Indian stock market appears expensive now. Last year, India got
a good share of flows from north Asian regions. Besides, Covid third wave still remains a risk for
the country,” he said.

HSBC has pegged India's FY22 GDP growth at 8 per cent in fiscal 2021-22 (FY22) with the first
half likely to be weak, led by both the direct and indirect cost of the second wave. “But we remain
positive about growth prospects in the second half, by which time a critical mass of the population
will be vaccinated.”

Manish Kumar, the Chief Investment Officer, ICICI Prudential Life Insurance Limited believes
that the current valuations are justified, given ample monetary and fiscal stimulus and record global
liquidity.

Indian equity markets have rallied and are hovering around all-time high levels now. Valuations
are elevated, but one has to evaluate valuations in the context of earnings and interest rates. We
believe that these valuations are justified given ample monetary/fiscal stimulus, record global
liquidity, low interest rates, strong earnings growth momentum, expectation of a cyclical recovery
(leading to strong earnings growth & surprise), record deleveraging that many corporates have
managed to achieve, rapid vaccination and benign infection rate. India’s earnings story has turned
better in FY21 after a decade of stagnant earnings and we are seeing sustained strength in the
earnings. We are happy to note that now positive earnings growth contribution is coming from
multiple sectors, which is leading to a broad-basing of earnings. Markets should be supported by
strong earnings and the global environment of low interest rates; but intermittent corrections are
par for the course. In some pockets of mid/small-caps, there definitely is some froth and those
valuations need to correct or earnings need to catch up there, leading to possible time correction
in stock prices.

Improving earnings trajectory indicates that the optimism in the equity markets is not necessarily
unfounded and is indeed backed by robust fundamentals, justifying the current market valuations.

Moreover, a closer look at valuations makes more sense when broken down across sectors. On a
standalone basis, although the Nifty is trading at 2x standard deviations above the long-term mean,
a breakup across sectors paints a different picture.

Half of the key sectors are trading at their mean valuations, while a few sectors that are trading
above the mean (such as IT) are justified because of the sectors’ significantly improved growth
trajectory and visibility.

Valuations at this juncture are still reasonable, especially when viewed across sectors and factoring
in the underlying fundamentals of the sectors. With metals, PSUs, banks and infrastructure still
trading closer to their mean valuations of the last ten years, they continue to offer further headroom
for valuations to rise.

Considering the broad parameters of valuations, the underlying earnings growth, and still strong
fundamentals, we are yet to enter the zone of irrational exuberance. However, it is critical for the
fundamental factors to sustain. Balance sheets of major companies have improved.

References:

https://www.5paisa.com/blog/9-factors-that-affects-the-indian-stock-market

https://indianexpress.com/article/explained/explainspeaking-decoding-rbis-monetary-policy-
stance-7445048/

https://www.business-standard.com/article/markets/indian-stock-market-valuation-a-concern-fdi-
flows-likely-to-continue-hsbc-121062900637_1.html

https://theprint.in/opinion/indias-market-cap-to-gdp-ratio-higher-than-china-thats-just-one-
reason-to-stay-invested/667578/

https://economictimes.indiatimes.com/markets/expert-view/no-pocket-of-the-market-is-safe-
now-keep-your-asset-allocation-balanced/articleshow/85360466.cms?from=mdr
https://economictimes.indiatimes.com/markets/stocks/news/irrational-exuberance-are-we-near-
the-shiller-mark-that-can-trigger-pain/articleshow/85265082.cms

https://www.newindianexpress.com/business/2021/mar/31/fabulous-fy21-india-biggest-recipient-
of-fpi-inflows-worth-rs-26-lakh-crore-2283990.html