We are starting to see a bottoming out of corporate earnings in India, and expect the earnings to rise in second half of FY18 and pick-up more meaningfully in FY19.
2017 has been a good year for equity markets, helped by record high institutional flows from domestic mutual funds, and also a recent pick-up in foreign portfolio investor (FPI) flows.
The calendar year 2017 up till November, mutual funds registered net equity inflows of the equivalent of around over USD 17 billion, while foreign portfolio investors (FPIs) recorded net equity inflows of around USD 9 billion over the same period.
Over the past 3 years, mutual fund equity flows have been around 2.5X FPI flows into equities, indicating the growing importance of domestic investor’s participation in the Indian markets.
Investors have also been gradually shifting from traditional physical assets to financial assets, and this has especially picked up pace post de-monetization.
Some of the reforms of the government have started bearing fruit, with India’s ranking jumping by 30 places in World Bank’s Ease of Doing Business 2018 rankings, from 130 in the previous year to 100 in this year—making it the biggest jump for any country in this year’s rankings.
Some of the key things to look out for in 2018 are as follows:
Corporate earnings revival:
We are starting to see a bottoming out of corporate earnings in India, and expect the earnings to rise in second half of FY18 and pick-up more meaningfully in FY19. The markets will be closely tracking this, as it has already priced in this revival. Any disappointment on this front may pose headwinds for the markets in the near term.
Market valuations seem to have priced in recovery in earnings growth:
With corporate earnings being muted over the past few fiscal years, the rise in equity markets has been helped by PE expansion.
Currently, the market is trading above its long-term average, although on certain other metrics like P/B ratio and Market Cap to GDP ratio—the markets look fairly valued.
Certain segments like mid/small-caps, which have outperformed over the past few years, are presently trading at significant premium to large-caps and investors should review their asset allocation in this space.
Economic growth on recovery path:
India had seen some deceleration in economic growth over the past year, but we expect growth to gradually pick-up over the coming year, led by pick-up in consumption and also a gradual recovery in investment.
GDP & GVA growth picked up in Q2 FY18 from multi-year lows, and we expect the recovery to continue, helped by various reforms by the government bearing fruit.
Although the capex cycle remains currently in doldrums, we expect the PSU bank recapitalization initiative to contribute to a pick-up in credit growth, which could trigger a capex recovery over the coming quarters.
Concerns about fiscal slippage this year is keeping interest rates high:
We expect the interest rate cycle to have bottomed out in India unless inflation and economic growth surprise significantly on the downside. Rising crude oil prices, and any fiscal slippage pose some upside risk to inflation, along with the implementation of salary and allowances hike by the state government.
On the fiscal front, the deficit has reached 96 percent of the budgeted estimate for the full year during the first 7 months of FY18 (April-October 2017), compared to 79 percent in the year-ago period.
State fiscal deficits have been rising and there is some concern about fiscal slippage due to GST rate cuts, and the PSU bank recapitalization initiative. Current account deficit (CAD) is also expected to rise in FY18, compared to FY17, due to rising trade deficit.
An eye needs to be kept on movement on crude prices, which may pose some pressure on CAD for an oil-importing country like India. However, even if there is any slippage, we expect fiscal deficit and current account deficit to remain within the comfort zone, and not be a major disruptive factor for markets.
Globally, the easy monetary policy is on its way out:
Major central banks have started to tighten monetary policy or withdraw policy stimulus, as global growth and inflation pick up. As expected, the US Fed hiked rates in its December 2017 policy and expects three rate hikes in 2018.
The Fed had also started to unwind its balance sheet from October this year. Thus, investors need to keep an eye on global monetary policy and any pick up in pace in monetary tightening or hawkish signals by the central banks may pose some risk to flows into emerging markets, thereby causing some headwinds to the Indian markets as well.
In a nut-shell, we expect economic growth to pick-up in India, accentuated with a revival in the corporate earnings cycle, which would augur well for the markets over the medium to long-term.
However, investors need to moderate their return expectation from equities in 2018 compared to 2017, as some of the positives, seem to be priced in, and we need to give time for corporate earnings to catch-up.
Over the long term, market returns will reflect GDP growth and corporate earnings growth, and therefore investors should carry on investing in a disciplined manner to build wealth through the compounding effect of equities.
After all, legendary investor Peter Lynch had once said—“In the long run, it’s not just how much money you make that will determine your future prosperity. It’s how much of that money you put to work by saving it and investing it.
More Will Update Soon!!
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