India’s sovereign rating upgrade by Moody’s was a positive development and pleasant surprise. Although there was some talk that we may see a ratings upgrade after PSU bank recapitalization but no one expected it this soon and also given the way oil prices were rising as well as the uncertainty around tax collections because of GST. As far as the equity markets are concerned, this is more of a sentiment boost. For companies with dollar cost borrowing, it will help. This will also increase pressure on the government to stick to its fiscal deficit targets.
The concerns about fiscal targets being eased and high oil prices continue to weigh on the bond market for some time. However, for the equity markets, the concerns are also about valuations and lack of earnings growth acceleration. By and large, the September quarter also hasn’t seen strong earnings growth.
Sentiment towards India is structurally quite positive. We have seen some foreign selling in recent weeks and months, but that is more because of people trimming their positions and taking profits. At the margin, there are global investors who are finding some other markets relatively more attractive but there is no negative sentiment on India. On the contrary, it is because of the reforms the government is conducting that the general sentiment towards India is still quite positive. In fact, most foreigners are waiting for a correction to buy.
We have been seeing a lot more foreign investors’ allocations flow to China. Earlier, it was Japan as well when Prime Minister Shinzo Abe won the election. And the rise in US bond yields has also affected flows into emerging markets in recent weeks with money rotating back into developed markets. China may seem cheaper, but the risks are also higher whereas India’s fundamental underlying long-term economic outlook is very robust. Our macro economy is in a great shape, that’s why Moody’s has upgraded. The government’s balances are getting better and easing of fiscal deficit, even if it happens, will be a minor slip. If anything, the quality of government spending is improving and corporate deleveraging is underway. The government is not resorting to populism. To that extent, most global investors are upbeat about India in the long term. While there will always be some valuation related switches from one country to another but the global investors are structurally positive on India. The recent selling by foreigners is not necessarily a negative view on India.
It is going to be difficult to justify a further valuation re-rating upwards, especially given that big interest rate declines are unlikely next year, so the market returns should be in line with earnings next year. Now it still remains a question mark whether earnings will improve in the 10-15% range or will it be in the 15-20% range or more. The earnings expectation is somewhere between the 15-20% range so the market should roughly rise by the same amount.
The opinion polls are suggesting the ruling party will win the Gujarat state elections. If that is the case then frankly there will be no major impact. If anything, there will be a marginal positive impact on the markets from a sentiment perspective. If there is any surprise loss then there will be a bit of a correction and concerns re-emerging on whether the general election in 2019 will result in political instability or change.
The Fed is what you have to watch for. We may see more EM outflows because of US bond yields rising, worries that Fed will continue to hike rates and that the balance sheets in Europe and the US will get tightened next year. However, as long as India continues its structural reforms and the economy continues to accelerate, we will continue to get a fair share of the global flows. If rates start going up in the US, India is a relatively safer play. The worry for India will be if oil surprises and starts going up even further. Then yes, flows to India will be affected.
As far as oil is concerned, our house view remains that oil will stay between $50 and $60 next year. What we are seeing right now is a temporary increase. We expect a correction in oil after the winter season passes.
The oil & gas sector remains one of our top over weights. Consumer discretionary, IT services and cement are other key over weights. In terms of what we don’t like, NBFCs and pharmaceutical sectors are the two main sectors we recommend an underweight on. We’re cautious on consumer staples also. The telecom sector is seeing signs of consolidation but stock prices have moved up quite a bit and there are still risks of the price war continuing which may disappoint earnings expectations. Our strategy team has an underweight call on the sector.
IPOs are always a function of how they are priced. Wherever we have seen good quality IPOs being priced reasonably we have seen very strong demand and wherever you have seen pricing being more aggressive, then we have seen low subscription levels. Insurance IPOs have attracted a huge pool of money. A lot of FIIs who otherwise may not have invested in India have invested.
This is a new sector and has attracted new global capital into India.
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