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Consumption, infrastructure themes to have long legs in 2018

Earnings of Indian companies are going to see some recovery after a long wait

The year 2017 started on an ominous note with the effects of demonetization lingering on. Sudden withdrawal of high currency notes (approximately 86 per cent of currency in circulation) on November 8, 2016 disrupted business and commerce. Effect on informal economy was particularly disastrous, as they were completely dependent on cash economy.

From utter confusion, where finance ministry and RBI were changing rules on daily basis to fight the fire unleashed by it, the script for stock markets changed as the year progressed. Before 2017 came to an end, S&P BSE Sensex touched new high of 34,000. As we update, S&P BSE Sensex has appreciated by 28.77 per cent in 2017. This handsome return still pales in comparison to performance of mid cap and small cap stocks. S&P BSE Mid cap index rose 48.8 per cent in calendar 2017. This is the 4th year consecutively when mid cap stocks have outperformed the largecap peers.

Among sectors, consumer durables, real estate, metals and telecom clocked the highest return in calendar 2017. Healthcare index was worst performing with 0.92% gains followed by IT services at 11.94 per cent return. Headwinds in terms of lower demand and regulatory scrutiny have respectively impacted both the sectors which predominantly depend on exports.

FII money continues to come to India, though the pace has slowed than a few years ago. FIIs invested $7.73 billion in 2017 as compared with $2.9 billion in 2016. On the other hand, domestic institutions have been pouring money is stocks backed by strong inflow in their funds. MFs witnessed massive net equity inflow of Rs 1,253 billion ($19.5 billion). This is 2.7 times net inflow of 2016 and highest in recent history.

Macro-economic situation in India continues to remain stable. Inflation is likely to remain comfortable within 5% range, even as it has climbed from very low levels witnessed earlier. India’s trade deficit is also under control given crude prices have been range bound. Fiscal deficit, however, looks to breach target of 3.2 per cent.

The government has already spent 96 per cent of budgeted deficit with another 5 months to go in the current fiscal year. Interest rates remain low currently, and there are upside risks to it. The current government got a windfall of stability as crude prices fell from over $100 a barrel to $40-65. This saving could have been used to make the economy stronger.

One of key policy action from the government was the GST rollout w.e.f. July 1 2017. There still are glitches in the system, however it is expected to benefit the economy by higher compliance and simplified structure. PSU banks, which needed capital for quite some time, are likely to see Rs 2.1 lakh crore infusion. In a surprise move, rating of Indian economy was revised upwards by Moody’s.

Earnings of Indian companies is seeing some recovery after a long wait. In the past 3.5 years since new regime came to power, hopes of recovery have been belied. Analysts were forced to cut their earning estimates as reality was different from exuberant environment they created. Even for the current year, the actual earnings are likely to be lower than estimates put earlier.

We see a good growth in earnings on the horizon. Global economic growth now seems fastest since the global financial crisis of 2008. This is likely to see better demand for exporters. Growth is picking up domestically as well, as recent data suggests. Impact of demonetization and GST-led destocking are now behind us.

Private capital spending, which has been subdued, is likely to pick up and drive GDP growth. Higher domestic as well as global recovery is likely to increase capacity utilization. Indian companies created capacity in boom years until 2011,while there was demand slowdown post 2008. Companies are likely to invest in capacity in not so distant future. They will also see pricing power benefiting their earning as capacities run out in interim, demand outstripping supply

While impending earning growth is good news for equity investors, the unfortunate part lies in valuations. Most of the back ended recovery in profits is already reflected in current stock prices. Sensex PE ratio continues to trade above its historical average. There are few sectors and stocks which look to be priced sensibly for investor to make meaningful returns. High level of liquidity globally due to loose monetary policy by central banks has distorted prices across most asset classes. The situation can change in future as few central banks are raising rates while some others are reducing the size of economic stimulus.

We remain long-term bulls on the Indian economy. It is likely to be one of fastest growing economies for many years to come. Consumption and infrastructure investments are themes for India which have long legs. Being bottom up investors, we are cautious in the near term as valuations are a challenge. If the markets fall anytime, we will use the opportunity to fully invest our cash. Retail investors can continue to invest through systematic plans However, large lump sum investment should be discouraged at this time.

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