What Returns should we expect from the Indian Stock Market in next 3 Years?

Analysis based on Market Cap to GDP Ratio

Market Cap-to-GDP Ratio

Market Cap to GDP is a long-term valuation indicator. The stock market capitalization to GDP ratio is a ratio used to determine whether an overall market is undervalued or overvalued compared to a historical average.
If the ratio is trading at a premium then the market is going to be negative in the next 3 years, because it is considered a parameter of overvaluation.
And if the ratio is trading at discount (Market Cap-to-GDP Ratio is below 100%) then it is considered as a positive as the market may be undervalued.

Formula :
Market Capitalization to GDP Ratio = (Market Capitalization ÷ Market GDP) × 100

Market Capitalization

Market Capitalization is the aggregate valuation of the company based on its current share price and the total number of outstanding stocks. It is calculated by multiplying the current market price of the company’s share with the total outstanding shares of the company. When the market capitalizations of all the companies are added then the resulting value is the whole market capitalisation.

Nominal GDP

Gross Domestic Product (GDP) is the broadest quantitative measure of a nation’s total economic activity. Nominal GDP refers to a country’s economic output without an inflation adjustment. Nominal GDP will often appear higher than real GDP.
There are many arguments relating to this like the above only holds true in the cases of developed markets and not in the cases of emerging markets.
So, now let’s test the historical data to find out of the ratio really work for the Indian markets and then analyze what can be expected from the market in the next 3 years.

• In December 2007, market cap had a 34% premium over the GDP. And we all know how the markets started falling from January 2008. After 3 years, the index was at the same level. Sensex gave a CAGR of -1.2% in those 3 years.

• During March 2009, the market was already impacted by the Lehman crisis and then the Satyam scam again made the market fall more. The market was trading at discount compared to the GDP level. In March 2012, the market reached the level of 17,750. Sensex gave a CAGR of 22.2% to the investors in those 3 years.

• In October 2010, the ratio was almost balance. The market was trading at 18,800 after 3 years in October 2013. Sensex gave a CAGR of -2% to the investors in those 3 years. After this period the market started its rally.
• The market was trading at discount of 42% compared to the GDP level, in August 2013. In the next 3 years, index reached 28,450. In this period, Sensex gave returns of almost 16.5%.

• In February 2016, when compared to the GDP, market was trading at a discount of 36%. Today, that is in February 2019, the index is at 36,000. Here too, investors got a CAGR of 16% in the last 3 years.

• In January 2018, the market was trading at a discount of hardly 4%.

So, now what can be the returns in the next 3 years?

• From January 2018 to February 2019, market is at the same level of 36,000. But the market capitalisation had reduced from Rs. 156 lakh Cr to Rs. 140 lakh Cr. The large cap index is at the same level, but the broader market has been majorly corrected. This means that there were lesser correction in large cap and more corrections in mid & small cap. The major section of a market is large cap, and still if the market has fallen so much, then it means that small and mid-cap look more attractive.

Summary

• So, in the next 3 years, mid & small cap looks attractive on the basis of risk-to-reward ratio.
• The next 3 years can prove to be very rewarding for the investors as Market Cap-to-GDP ratio is at 75%, that is market is trading at discount of 25%, which looks very attractive.
• There are 2 things that can happen from here on:
  • The market may remain sluggish for the next 6-7 months, GDP will keep increasing and the market will look more undervalued, OR
  • The market may pick-up from here on immediately to grow and give good returns.
• This is a great time for investors to design and develop their investment portfolios.

Notes: –

• The numbers that are used are approximate and have been rounded for presentation purposes.
• Only an analysis has been presented here. No judgments or final statements are being here.