Mishra also says that deep corrections become very difficult when mutual funds are sitting on Rs 1.25, 1.5 trillion, over Rs 1 lakh crore of cash. So whenever there is a 4-5% drop from the peak, there is a spate of buying. So equities as an asset class are not seeing sharp drawdowns and in the short term make it safer to invest in and attract more funds, so that is the cycle we are in.
How do you see the global economy and markets five years from now?
Neelkanth Mishra: As we think about the world in the next five years, I think the pace at which capital formation is triggered by the opportunity for exports and goods and services is going to be a lot lower than it was in the 2003 to 2008 period. There are ways to accelerate this process. So, if, for example, we were able to improve ease of doing business, significantly simplify our taxation structures for corporates, especially foreign firms, and equally importantly work on urban infrastructure because that is a space where a significant amount of capital formation needs to happen.
There is a big gap between demand and supply and if we can get urban infrastructure investment to accelerate in the next five years, then potentially we can do a 7.5-8% growth because that is an area where we need to invest and if we can, it will help sustain the real estate cycle for much longer. So, there are ways of getting about it. But I do see significant challenges in going well above 7%.
Where does it take us in terms of the market cycle? When we are already at a peak performance rate on growth, higher growth from here on comes with its own challenges and to-do list. The Indian market is trading at a premium to other emerging markets and many other globally well-traded markets. Unless and until the entire composition of the market sees growth acceleration in earnings, we are susceptible to some corrective phase.
Neelkanth Mishra: The real GDP of FY25 has been revised up by nearly 3% points over the last year, which is a substantial revision. And what it does is it bumps up the demand for many goods, and services, assumed demand for goods and services and that upgrade drives a very positive momentum on PE multiples. So, the assumption and expectation and which is why I think the PE multiples have held up despite the high cost of capital, and high risk-free rates in the world. If GDP growth acceleration cannot be sustained, meaning that the upgrades to GDP are not going to happen even further, meaning that we are already at 7-7.5%; most people are now assuming that. Now, if we do not have the steam, given all the global headwinds and all the concerns that exist of going above and beyond the 7.5% to say 8% plus, then perhaps this expansion in PE multiples may not be sustained.
Therefore, we could see a period of a bit of time correction. On the technical side or rather, let us say the flows side, generally flows tend to be turbulent, and therefore they do not sustainably raise PE multiples. But what we are seeing and what we have been seeing in the last three years is a very steady stream of inflows which are still rising. So, when I started flagging these so-called unintended flows several years back, I used to talk about $25 billion a year, $20-25 billion a year. Now, if you just do the math, these numbers are like $40 billion a year. So, there is a significant increase in this steady flow of funds, unintended capital flowing into equity markets and this is a very powerful driver of PE multiples. This is likely to keep the multiples elevated.
Remember that deep corrections become very difficult when mutual funds at any point in time are sitting on Rs 1.25, 1.5 trillion, over Rs 1 lakh crore of cash. So whenever there is a 4-5% drop from the peak, there is a spate of buying. That drop in volatility of the asset class, meaning because the equities as asset class are not seeing sharp drawdowns, actually in the short term makes it safer to invest in and attracts more funds, so that is the cycle we are in.
It will be wrong to just look at PE multiples and say they are too high, which they are, and say that that is why they are going to correct. But I do think that the first factor, which was a steady upgrade to trend growth assumptions may start to slow down now and therefore, my view that we should see some time correction in the markets going forward remains intact.Within the market, if one were to divide it in market cap terms just for better understanding, the top 100 companies which includes large and mega caps, and then the rest, which is a broader market and is seeing a massive healthy addition on new IPOs. So, categories are opening up. In which part do you see the valuation versus earnings growth argument not in favour?
Neelkanth Mishra: I still think that if it is a flows-driven argument, then it is very important to plot how flows are happening as a percentage of relevant market cap. And there I see that the flows to smallcap and midcap funds and the measure we use is 12 months of flows, like the last 12 months or rolling 12-month flows as a percentage of the market capitalisation of that sector or that segment. So, those flows for small and midcaps had reached 1%, 0.8% to 1.2%, that generally is the level at which we have seen historically those levels sort of falling off from, that it is peaking at.
And so, we have seen that, now there is a bit of a correction that is starting to happen. Largecaps, on the other hand, because of this preference, because incrementally savings were being directed towards small and midcaps, the flows argument on large-caps, may pick up from here, and some of the things that we have seen recently like the rebound in bank stocks because the concerns around NIMs, etc, are kind of now fading, I mean, incrementally not a lot of more pressure coming on NIMs, we have seen telecom tariff hikes. So, in general, the large caps seem to be better supported than the mid and small caps.
