How do you distinguish whether you are at the peak of a bull rally or at cusp of the next bull rally? The answer is simple. Don’t look at what the markets are doing. Rather look at what companies are doing. We often tend to get obsessed with the level of the Sensex and Nifty. If you look back at the last 3-4 rallies in the market, each rally has been followed by a correction and each correction has been followed by a bigger rally. If you are still looking at the markets you are making the wrong choice.
Instead look at what companies are doing
When you come across this dilemma; end of rally versus beginning of rally, always go back to the 2003 rally in the stock markets. Around early 2005, the peak levels of the 1999 rally when Sensex had touched 6,100 had been breached. At that point, most traders and experts had called the end of the 2.5X rally. However, that proved to the start of a bigger rally. The Sensex rallied from 6,100 to 21,000 by 2008 and today the Sensex is at almost 53,000. What did companies do in the 2003 rally?
To begin with, the government gave a massive infrastructure push with the Golden Quadrilateral. That was the first time that India realized the potential that infrastructure had as a growth engine. Then the RBI ensured that rates remained at abysmally low levels to ensure that credit was easily available to businesses and individuals. Thirdly, the companies borrowed heavily and also undertook massive capital expenditure programs. The net result was that it created virtuous cycle of more growth bringing more investment and more investment again bringing growth. The whole story was nixed by Sub-Prime crisis but that is a different story altogether.
Corporate growth and stock markets – what happened globally?
Let us look at some global experiences of how the stock markets in the respective countries reacted to corporate profit and economic growth triggers. Remember the Buffett ratio of market cap to GDP; this is another way of looking at the whole story. You would be rather surprised to know that some of the most frenetic bull markets in the world happened when the GDP of the nation expands from the $2 trillion level to the $5 trillion level. Let us look at some live global experiences.
a) Let us consider the example of the world’s largest and oldest big bang growth story, the United States. The US economy touched $2 trillion GDP in 1977 and it took them another 11 years to scale $5 trillion in GDP. That was the phase of the longest bull market in the US which lasted from 1977 to 2000. During this period, the Dow Jones Industrial Average was up 17-fold from 700 levels to 12,000 levels.
b) If you look at the Japanese economy, it scaled from $2 trillion to $5 trillion GDP in 9 years and during this period, the Nikkei index was up nearly 19-fold during this period, almost similar returns to the US; in fact, a tad better.
c) In the case of China, it moved from $2 trillion GDP to $5 trillion GDP in just 5 years and during this period, the Chinese index was up nearly 4-fold. However, the Chinese market is a largely controlled market, unlike the US and Japan, so it may not be exactly comparable.
What does this story mean for India? For starters, the move from $2 trillion to $5 trillion could be significant for Indian markets too. India’s GDP is around $2.7 trillion at this point of time. The Sensex was around 30,000 when the GDP was at $2 trillion. Assuming that India sustains real GDP growth at around 6%, we should touch $5 trillion GDP by 2031. Perhaps, the rally of 17X or 19X may not happen in India as a lot of optimism is already build into markets. But even if we assume a conservative 5X expansion, we are still talking about Sensex at 150,000. Today, the number may look weird, but technically that is the kind of returns that is perfectly possible.
What can trigger the next big rally?
Indian markets are big buyers for the growth plus investment argument. Here are some triggers that could put Indian markets in a different plane.
- With capacity utilization likely to pick up rapidly, you can expect a slew of expansion plans in the coming years in industries ranging from cement to capital goods and oil. That is likely to be value accretive.
- Secondly, the PLI scheme to encourage local manufacturing will be a big opportunity for India in terms of utilizing capacity, outsourcing opportunities and expanding exports. This is likely to be one of the biggest triggers for the Indian markets.
- Finally, the low interest rates look unlikely to change for the time being. That is an important ingredient for any sustained bull rally.
It is hard to say when and whether such a bull rally will commence, but the setting is right for the mother of all bull markets. It is now for the economy to live up to the optimism.