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How a change in complexion alters game plan for Indian stock market


The complexion of the domestic stock market changed in Calendar 2018. From a midcap-led market, the focus suddenly shifted elsewhere. Midcaps lost sheen and have dropped considerably from their peak levels. In part, the change coincided with the re-imposition of long-term capital gains tax on equities and Sebi’s reclassification of mutual funds.

The midcap selloff became worse because of strong FII outflows during periods of rupee weakening and the surfacing of the IL&FS crisis.

India saw a strong bout of FII selling during the year. Emerging markets as an asset class did not look too good thanks to US sanctions on Iran, trade war and other factors.

Equities across emerging markets saw strong redemption pressure and India had its share of selling too. India-specific issues like currency depreciation on strong oil prices in September and the IL&FS crisis did not help matters. While earnings are expected to expand by around 14 per cent in FY19, the market is on course to end nearly flat.

This has ensured that valuations are much better now than they were at the start of the year.

Valuations are defendable: The New Year brings hope of easing of some the issues that kept the market sub-par in CY18. Valuations that were high at the beginning of the last year have corrected considerably. This provides a big comfort. At 16.5 times FY20 earnings, valuations are now defendable and one should expect to get returns in line with the growth rate, compounding into future.

Here it is important to understand that a lot of growth expected in FY20 over FY19 would on account of base effect, particularly in the PSU banking sector. We believe sectors which are best placed to deliver compounding of earnings should perform better.

Expect softer global growth to keep commodity prices soft: While oil prices can rise again on an OPEC deal, however, at the moment they are lower than they were at any point in the year. This provides big support to margins of India Inc and supports the India growth story. Global growth should be softer in 2019 than in 2018 given the issues that have to be dealt with. US-China trade spat seems al set to continue. Brexit would have to be dealt with. Like the Fed, ECB would also start to taper and that should have a bearish impact on commodity prices. Already prices of metals and oil are down.

Consumption to remain the key growth driver vs Capex or exports: Growth in consumption would be supported by lower interest rates, good monsoons in 2018 and successive farm loan waivers that are being announced. The focus on rural investments would also help boost consumption.

We do not expect capex to be a significant growth driver this year. The government has been the biggest spender on capex. If we see strong wave of populist measures like farm loan waivers by state governments, the money left for capex would reduce. Private sector capex has stabilised but most of the larger houses, which are still bankable, are opting to buy stressed assets rather than focus on greenfield or brownfield expansion of capacities.

Exports, the other growth engine, should not be expected to be a growth driver in the New Year. Governments around the world focussing on protecting domestic markets, and thus generating big growth in exports would be difficult. A sizeable depreciation of the rupee may have helped but our competing economies have seen similar currency depreciation and, hence, this has not been a big support.

Aquaculture, which has seen rapid growth, should see consolidation in the coming years, as the industry faces higher scrutiny in western markets. IT services are very dependent on depreciation of the currency for delivering over 15 per cent growth, while industry prospects have improved vs last few years. Generic pharmaceuticals continue to face higher compliance costs. This is no longer seen as a defensive industry.

There are a few sectors that would benefit from the Chinese economy making its pollution control norms more stringent. China is also focussing away from labour-intensive low value-add manufacturing. While it seems that industries like garmenting is moving to Bangladesh and Vietnam, and electronics to Thailand and Malaysia, India does seem to be able to expand its presence in chemicals substantially. The chemicals industry requires an ecosystem where discharge from one industry can be used in another and this is something very difficult to achieve and can provide Indian industry with a great advantage.

Our outlook on flows: On the flows front, we do expect the domestic flows to equity to persist given the low allocation to equities in Indian portfolios. This has been an enduring theme over past few years and should continue.

While profitability of distributors would get impacted in the new fiscal as lower commissions are shared on regulatory intervention, yet the business remains very profitable.

On the offshore side, India has a great chance to position itself as a safe haven amongst emerging markets. Unlike other emerging markets, we are not commodity driven and actually benefit the most by low oil prices.

Our stock valuations have corrected and can be defended well on absolute basis though on relative basis other countries may look cheaper. However, other countries have their own issues in trade wars, sanctions etc. that we are not impacted with. Very few companies in India get impacted by an event like Brexit which should impact a significant percentage of corporates in more global economies.

CY2018 saw strong FII selling in India on EM outflows and also country specific outflows on risk aversion, currency depreciation and local issues like ILFS. India which used to be an overweight in global emerging market portfolios became inline.

We expect the New Year to see a more neutral

stance as country specific flows gain positive momentum and neutralise any outflows from emerging markets.

Market Outlook: Corrections in stock valuations and oil price reduction are big positives for the Indian market. Let us look at which spaces are best placed to deliver strong growth in the new year.

Our belief is that consumption and financiers of consumption would continue to remain in focus. Consumption would be supported by continued low inflation and prospects of low inflation as the benefit of lower crude oil prices is passed on. Spends during elections would serve as a multiplier.

Loan waivers should help. Interest rates which were going up have a great prospect of falling in the New Year, if the fiscal targets are adhered to. This again should help consumption. The spaces to watch would be FMCG, durables and auto. Buoyancy in consumption should help financiers in auto, CV, smaller homes, gold, microfinance and SME segments.

Metals outlook has suffered on prospects of lower global growth rates. Domestic prices are now supported by minimum import prices (MIPs). While this may protect the downside, any upside

would be difficult.

The high quality-high sustained growth space has corrected in valuations. A large part of this space has pricing power and should benefit from improved margins as commodity prices correct. This is a part of the market that we have been exposed to and we believe that this part has a great chance to deliver sustained low volatility returns.

Happy investing and A Happy New Year!

(The author is Business Head and CIO of ASK Investment Managers. Views are his own.)

Source: Economic Times