India shining

In the early 1990s, just post-liberalisation, investors often remarked on the disconnection between the corporate sector and the macro-economy. At that time, private capital and management contributed a very small share of manufacturing and services.

Earnings trends were often out-of-synch with the gross domestic product (GDP) trend. The private contribution is much larger now. As the ratio of private contribution has arisen, corporate performance has aligned with GDP. If it's a good year for macro-economic growth, it's a good year for India Inc.

There is a handsome premium. In the past five years, GDP has grown at somewhere between 6-8 per cent per annum with inflation at about 6-7 per cent. The Nifty's averaged earnings have grown at an annualised rate of 27 per cent and the major market index has offered a price-return of about 40 per cent per annum. So there's been an earnings premium of about 10 per cent over the sum of GDP plus inflation and of course, a further premium of 13 per cent in price-returns over earnings.

Can this happy state of affairs continue? Well, there does seem to be a premium for corporate performance in every healthy market. US GDP has moved at somewhere between 2-3 per cent since 2002, with inflation in the 2-3 per cent region. Corporate earnings have grown at nearer 10 per cent and the Dow Jones Industrial Average has returned over 13 per cent compounded annual growth rate (CAGR) in the past five years.

The next five years will see enormous investments. The Planning Commission hopes that during 2007-12 (the period of the XI Plan), over $500 billion will be pumped into new infrastructure projects. It assumes that at least 30 per cent of this will come from private sources. That means both FDI and FII and also Indian household savings channelled through IPOs and vehicles like mutual funds and insurance units.

It isn't farfetched. The rupee IPO market can easily raise Rs 100,000 crore per annum. That means eight DLF or ICICI-sized issues or perhaps 4 mega-issues and another 10-15 smaller ones. Good infrastructure IPOs will be lapped up, going by examples like NTPC, PowerGrid, PFC, GMR, Idea, RComm, Reliance Petro, etc.

Consider FDI and again, the money's surely there. China picks up over $50 billion FDI per annum India can surely absorb $20-30 billion without too much effort. If that money is gainfully employed, capacities would double across most bottleneck areas and perhaps for the first time since Sher Shah built the Grand Trunk Road in the 1550s, growth would not be hobbled by infrastructure constraints.

It should be possible to maintain 9 per cent GDP growth or even aspire to double-digits. The premium on corporate earnings may drop somewhat. But the Nifty's Earnings should still grow at 20 per cent or more. If the premium of price-returns to EPS growth holds, the indices should return better than 20 per cent per annum. Obviously infrastructure-sensitive sectors should return more.

It all seems very convincing in theory. In practice, the next 18 months will be fraught and the resolve of long-term investors will be tested. There will be a general election followed by another coalition government. Eventually some version of this broad vision will come through but there will be intervening uncertainty.

In September 2005, a technical analyst named Milind Karandikar made a bold prediction in this publication that caused some shock. He said that the Sensex (which was then at above 8,000) could be somewhere "between18,000-40,000 within the next five years." Also, that he expected a major rally to last till mid-2010 and then be followed by a five-year consolidation.

In the event, Karandikar's lower limit has been crossed within two years! From here to Sensex 40,000 (about Nifty 11,500) by mid-2010 implies an index return of 16 per cent per annum. That falls well within the bounds of rational probability since the long-term market return is higher than 16 per cent.

People often sneer at technical analysts. But Karandikar's predictions can be validated by broad macro-economic logic tied to GDP and earnings projections. Remember this and invest heavily if the market drops like a stone during the next general elections or during the lead-up. That is perfectly possible - remember May 17, 2004? For a long-term investor, every dip from now onwards should really be viewed as an opportunity.