By Vinay Sharma
Fund Manager, Reliance Mutual Fund
Domestic markets are currently faced with a paradoxical situation of record highs for few indices while a large part of the market is much lower from the previous peaks. This has come after stellar bull run of the previous year. 2018 has witnessed higher volatility with the recent macro data especially on Currency, Oil etc. causing some jitters. On the positive front, various concurrent and leading economic activity indicators continue to point towards strong recovery in economic activity in India. While on annual basis, acceleration has been aided by the low GST base, the sequential improvement is also visible across data points.
While most high frequency indicators exhibited improvement, there were a few which showed sequential moderation.
Few examples:
- PMI: India’s manufacturing PMI eased to 51.7 in August from 52.3 in July, reversing gains made over the past two months. Domestic demand moderated a bit as evident in softness in new orders component of the survey.
- Auto sales: August data was mixed. Indian commercial vehicle industry reported strong volume growth in August despite concerns of regulatory notification regarding axle load. At the same time passenger vehicles and two wheelers industry witnessed softness in demand due to Kerala floods and overall heavy rains across the country.
- Job speak indicator: Naukri Job-speak index for July 2018 increased by 9%YoY led by sectors like insurance and real estate.
- Core sector growth: Core sector index which represents key infrastructure linked sectors
- Grew 6.6%YoY in July 2018, as against growth of 6.7% in June.
- Credit growth: Gross bank credit grew at 10.5%YoY in July 2018 as against 11.1% in June 2018.
- Cement production: Cement production grew by 10.8% in July after 13.2%YoY in June
- Freight growth moderated a bit in July. Port traffic growth dipped to 5.1%YoY in July, whereas railways traffic growth also moderated to 4.1%YoY in July.
We remain constructive on the equity markets due to following:
- GDP Growth: India’s real GDP growth rose to a solid 8.2%YoY in 1QFY18-19 from 7.7% in the previous quarter. The sharp jump in GDP growth was led by a pickup in domestic private demand and a lesser drag from net exports. Part of the growth acceleration has also been driven by base effects of demonetization and GST implementation. Adjusted for base, the underlying trend is running close to 7% (two-year CAGR). Strong growth momentum is likely to continue in a foreseeable future.
- Policy Reforms: Policy initiatives such as the Bankruptcy Code, GST, etc., emphasis on building infrastructure and reasonable good execution, we should witness the benefits of economic growth in equity investments.
- Improving Earnings and Activity index: Recent data points on various activities (such as 2W sales, PV sales, cement, steel production, etc.) are suggestive of pick-up in economic growth on the ground. Earnings growth of Corporate India also has been turning around over the last 3 Quarters.
- Robust inflows: Domestic flows into equities continues to be robust – for instance, Mutual Funds alone account for >1 Bn USD every month only through Systematic Investment Plans (SIPs). This seems to be a structural phenomenon than cyclical, and bodes well for equities.
Fund Positioning
As mentioned earlier we are witnessing a significant market polarization where returns have been concentrated in very few stocks presenting interesting investment opportunities in the remaining segment. Within them lie a host of solid businesses, which have the potential and visibility for robust earnings growth and yet are available at reasonable valuations. Our portfolios have optimal mix of current leaders along with such opportunities available at rational valuations and potentially superior growth possibilities over the next few years.
On a thematic front, we are positive on universal banks – banks that have a large share of corporate lending as well as retail businesses. The recovery in the corporate lending driven by the cyclical upturn, cleanup in NPAs and likely lower provisioning requirements can lead to a shift in the segment. Selective engineering, capital goods and infrastructure related sectors also look promising in the current phase of recovery. We are positive on export and import substitution companies, where ongoing trade disruptions in the world along with government focus on made in India can make a substantial difference.
Overall the equity outlook appears to be promising over the medium term. Earnings recovery is key theme to watch out for in 2019 and 2020, given the low base of previous years and improvement in micro environment. The recent macro challenges like high crude prices, currency depreciation and sticky interest rates impact near term sentiment and needs to be monitored closely.
Key risks to our thesis could be a prolonged trade war in developed economies which pulls down global growth sharply, upcoming domestic elections and current account deficit increasing even further.
Common Source: Bloomberg, RMF Internal Research
