PUTTING IT ALL TOGETHER
Valuations: PE ratio implies a possible drag of 5-6% from earnings growth
Earnings Growth: Corporate Profits to GDP well below historical average. Possible Mean reversion indicates 12-18% earnings growth environment
5Y Equity Return Expectation: 8% to 14%
5Y Equity Real return Expectations: 3% to 9%
Cycle – Credit Growth, Capacity Utilisation: Earnings growth to be supported by: improving credit growth and increasing capacity utilization (possibility of capex cycle picking up)
Sentiment: Negative FII Flows indicate strong returns in the next 2 years. High valuations were supported by strong DII Flows (primarily from mutual funds and new SIP culture). But early signs of fatigue in DII flows – needs to be monitored
Interest Rates: Lower Inflation + Interest rates may lend support to equity valuations
Other Dynamic Asset Allocation Models: All models indicate a not-so-positive stance on equities (due to higher valuations)
Momentum & Trend: Both are positive
We can classify markets into 4 cycles: Bust, Best, Boom, Bubble (borrowed from this interview of ICICI Prudential Sankaran Naren’s framework here)
All these indicators put together, indicate that we are not in a Bubble zone. The valuations indicate that we are neither in the Best zone. While mid and small caps have seen a partial bust, overall the markets in my opinion are still in the Boom zone as the earnings growth is yet to pick up and the start of earnings growth might lead to decent returns.
So for those who are investing now, different combinations of multi-cap and Dynamic Asset Allocation funds can be a good option.
Given the early signs of fatigue in DII flows, I am a bit concerned about mid and small caps and would rather play them through multi-cap funds.
- This is an evolving framework and I hope to update it every 6 months.
- I can be wrong, more often than not.
- This post reflects my personal views and not necessarily those of my organization.
- No content on this blog should be construed to be investment advice. All information is a point of view, and is for educational and informational use only.
This post initially appeared on The Eighty Twenty Investor blog and has been edited for Morningstar.
