India is a growth story with economy size of USD 2.5 trillion on way to become a USD 5 trillion over next decade. India was USD 0.5 trillion economy in 2002, crossed USD 1 trillion in 2007, USD 2 trillion in 2014 and the direction has been northwards despite headwinds over the global platform be it Lehman crisis, European debt crisis or US taper tantrums. The markets too have moved in tandem with the economy over these periods. The economy has grown at relatively slower pace over last few quarters due to implementation of two structural reforms (demonetization & GST) undertaken which would be benefitting the economic expansion in long run. The revival in GDP growth rate and corporate earnings are testimony of the same. We expect the trend to continue in near to midterm.
Given the growth potential of Indian economy and domestic corporates, the long term view on Indian markets is bullish. Ideally, the market cap to GDP ratio is in the range of 0.8 to 0.9. As the economy grows, the market cap will follow the suit and thus has the potential to emulate the growth prospects of Indian economy.
2. Valuation outlook :
Indian markets are currently trading at 18.3x one year forward neither very expensive nor cheap. But the mopping up of excess liquidity by global central banks, along with rate tightening can cause temporary risk aversion leading to further declines. Hence we expect the markets to consolidate with stock specific action in near terms.
We expect corporate earnings to grow at higher teens over next two year. Both IMD and private weather forecaster Skymet has guided for ‘normal’ monsoon for third year in succession ruling out probability of deficiency in rainfall. Good monsoon augurs well for the revival of rural consumption. GST tax collection has been improving and with implementation of E-way bill, the collection will further improve thus bridging the gap for the Government. Different steps taken by the Government to contain bond yields like reducing the borrowing programme, distribution of borrowing in both half of the year and relaxing the FPI limit for Indian bonds by 50 bps every year for next two years have been working. The corporate earnings are improving and are broad based except public sector banks. The Q3 results for retail banks, FMCG, retail, IT, engineering sector along with metals were good and their performance is expected to continue in near future. Overall, we expect the downgrades to be limited to couple of sectors like PSU banking or Pharma and the cycle of upgrade to start probably in Q1 or Q2FY19.
3. Global factors that could affect the markets :
Over last couple of weeks the domestic markets were facing headwinds mainly due to global developments on back of rising US yields, policy rate tightening in US and US China trade war. The policy rates which were low for almost a decade have been moving up and are expected to accelerate further in coming 12 months given the inflation and wage growth in US economy. Other developed economies viz., Europe & Japan are also expanding and process of unwinding of excess liquidity and probable rate tightening can commence in these economies sooner than later. These developments or possibilities are being factored in the yields which are on northward movement esp. US. Given the events lined up in near term, the markets are expected to be volatile. ECB has dropped easing bias indicating that the Euro zone economy is on better wicket and does not need additional stimulus and policy rate hike and winding up of QE is on cards probably in 2019. Rising crude oil prices are concern for India given the dependability on imports. Escalating tension is Middle East has potential to push crude oil prices further in wake of the fact that the fundamentals of oil are improving. Dropping supply from Venezuela, US decision on Iran nuclear deal etc would have bearing on oil prices.
Hence in near term, the markets are likely to be volatile in nature but over long term, Indian market would follow the growing Indian economy and the corporate earnings for its direction.
4. Indian macro environment :
The Inflation is expected to trend between 4.5-5% over next couple of months; RBI has maintained status quo in last meet on Apr. 4/5. The last GST collections has been increasing, reported at Rs 89,000 cr. for March 2018; e-way bill has been implemented from Apr.1, 2018 which will help plug the loopholes if any and help improve collections. If GST revenues start picking up sufficiently to be in line with the government’s assumptions for FY19 then the bond market may actually cool off from current levels. The oil prices currently trading at near $72/bbl are inching up following the likely supply demand mismatch due to expected rise of 1.5 mn bpd in 2018 vs 2017 (demand for 2018 is projected at 99.3 mn bpd vs 97.8 bpd in 2017), drop in oil production from Venezuela which used to contribute 2.5 mn bpd and is now contributing 1.6 mn bpd, tensions in ME and high chances of US reneging on US Iran nuclear deal thereby leading to imposition of embargo on Iran which would remove the 0.7 mn bpd crude supply from Iran from the global supply. The rising tension in ME is also going to help the cause. The corporate earnings have been in line with expectations and trending northwards. Going forward, the macro picture is expected to be impacted due to rise in oil prices. Domestic markets are likely to go through bouts of volatility time and again following the global cues, and domestic developments which include political developments but over long term, investors would be rewarded for their tenacity and patience for remaining invested.
5. Top sectors to bet on :
As India story is intact, be it rural or urban consumption, discretionary spends, infrastructure investments etc. look good. Auto and Auto ancillaries are good investment options given the under penetration and demand in this space. FMCG and consumer durable manufacturers would be beneficiaries of the rising spending power in rural areas along with improving electricity infrastructure in villages. Given the massive public spending by the Government for improving infrastructure, EPC companies with execution capabilities and light balance sheet are also good opportunities for investment. Housing and related theme like housing finance, home improvement etc are still looking good given the Govt.’s target of “Housing for all by 2022” and measures put in place for the same. The financialization and formalization of the economy has created ample opportunities for NBFCs and Pvt. Banks with retail focus, although there would be some pressure on this segment as the rise in domestic yields would increase their cost of funds for short run. As global economies are doing good, the export related segments like textiles and chemicals also has ample scope for growth. India holds advantage in these two sectors on account of India being largest cotton producer (thus secured on raw material front) for textiles and better production practices in chemicals industry where the West is looking for shifting production to East and India is considered as better option vis-à-vis China. In both Industries, India scores better due to lower labour cost, talented, educated workforce and stringent Intellectual Property laws.
6. Top sectors to avoid :
We would recommend staying away from IT and Pharma sectors. Though IT has reported fairly good results, the much awaited growth is still missing. The discretionary corporate spending in US esp. in BFSI sector looks to be still far away. Given the poor growth prospects we suggest our investors to look for domestic focused growth sectors.
Similarly, the pharma sector is also going through dull phase in its life cycle. In addition to USFDA issues which would probably get resolved in near term the pricing in US markets is worrying us. Hence we would recommend our investors to instead look for domestically focused sectors which have both growth potential and good pricing power.
Important results so far:
Infosys: Infosys Q4FY18 results were in line with market expectations, but the market was disappointed by the guidance of 6-8% vs expectations of 7-9%. In addition, the company lowered the target band for operating margin for the financial 2018-19 to 22-24% from 23-25% in the 2017-18. And the company has guided to distribute 70% of the cash generated in FY18 to its shareholders indicating that the company has limited plans for any inorganic growth.