Over the last two months, the Sensex has rallied over 12 per cent, breaking through its earlier peak and currently trades at a new high. While the recent up move may seem sharp, there appears to be further steam left. One, investors must note that the returns from the equity markets in the past six years have been nominal. The current uptrend may just be the beginning of a secular trend, as multiple factors such as political stability, macro economic data points and earnings improvement converges to support equity valuations.

Many of the pre-poll surveys suggest a decisive win by a large national party at the centre, leading to expectation of political stability and an improvement in business confidence. While there may be volatility post elections depending on the outcome; a gradual improvement in the business cycle appears quite imminent. This may drive the stalled capital expenditure (capex) cycle. The impact of such a revival will be felt in fiscal 2016.

India lures FIIs Foreign Institutional Investors (FIIs) have, meanwhile, invested a large amount of money in India. India with an expected 4.7 per cent and 5.4 per cent GDP growth in fiscal 2014 and 2015 respectively, improving Current Account Deficit (CAD) and the possibility of election-led change, imply an improving business cycle.

It is noteworthy that FII ownership in the BSE-200 companies has increased to 23 per cent (a whopping 47.3 per cent of free-float) as of December 2013; again a measure of rising confidence. The recent rally is driven mainly by cyclical and sector rotation theme. The initial phase was driven by large cap stocks, but recently we are seeing aggressive mid-cap, small-cap participation as well. This is indicative of a renewed appetite for risk.

Investor guidelines So, how can investors participate? While cyclicals hold good potential, investors need to be cautious and avoid highly leveraged infrastructure companies as interest rates are not expected to come down in a rush.

Instead, one of the best ways to benefit from improving economy, is through the banking and financial services sector. We also recommend companies with stronger balance in the capital goods and industrials sector. That may not automatically mean the IT and Pharma (so called defensive sectors) outperformance is behind us. This is because we do not expect the rupee to appreciate significantly from here as RBI may use the current strength in rupee to build its US dollar reserves As the capex cycle gradually revives, we may see the imports increasing, too, once again putting pressure on CAD and rupee.

Household savings into equity, have dropped significantly (currently 1per cent) from peak of over 7per cent in 2008. This highlights the quantum of underinvestment by Indian retail investors into equity. Investors can restart equity investments, with a time horizon of three years in mind. , The market (Sensex) currently trades at a P/E of 14.2 times forward earnings, which compares well to its 5-year average of 14.5x. As the capex cycle/business momentum improves and drives increased earnings growth, we would expect the market to be re-rated to a higher multiple. This should deliver strong equity returns over the next three years.

The writer is Co-Chief Investment Officer in Birla Sun Life AMC.

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