Emerging economic trends indicate good market returns in 2019

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Disruption is a word frequently used these days to signify the profound consequences of major changes in various realms of modern life. Disruptive technology, for instance, is impacting business in an unprecedented manner. Even though disruption is pervasive and dominant in technology and business, there is disruption in other areas too, like in economic, social and cultural realms. In this disruptive world, making predictions would be a hazardous exercise. Nevertheless, some trends discerned from market signals may prove to be profitable for investors in 2019 and beyond.

Global economy set for a slow down

After impressive growth in 2018, global economy looks set for a slowdown in 2019. The US, which re-emerged as the engine of global growth, has been on the second longest period of economic expansion in US history. If the current expansion, which started in June 2009, goes beyond June 2019, it would be the longest economic expansion in US history. This certainly looks likely; but a slowdown appears imminent. The flattening of the yield curve in US indicates slowdown. Global PMI in December, at 2-year low, is another indication of an imminent slowdown. However, the consensus is that a recession is unlikely.

Even though this ‘growth scare’ is a negative, it has positive implications for market performance in EMs like India. The growth scare is likely to turn the Fed’s monetary stance dovish in 2019. The Fed has already trimmed the number of rate hikes they foresee in 2019 from three to two. The sharp dip in US 10-year yield – from the peak of 3.26 percent in October to around 2.82 percent by mid December- has stemmed capital outflows from EMs. The declining yields are likely to trigger increasing capital flows to EMs like India.  EMs are likely to outperform DMs in 2019. This augurs well for the market.

Indian economic growth yet to gather momentum

FY 19 Q1 GDP growth at 8.2 percent indicated that the economy has overcome the twin shocks of demonetization and GST implementation and is set for resumption of robust growth. But the Q2 growth rate at 7.1 percent reflects weakness in the economy and raises doubts about economic recovery. Achieving 7.4 growth target for FY 19 would be a challenge. Decelerating growth rate will also impact the tax revenue, particularly GST, which, in turn, will render achieving the FD target of 3.3 percent extremely challenging. However, this weakness in the economy, coupled with benign inflation, can lead to an accommodative monetary policy, perhaps as early as April 2019.

Monetary stance will turn accommodative

The crash in crude and soft food prices have brought inflation well below the RBI’s comfort zone. The central bank expects H2 FY19 inflation to range between 2.7 to 3.2 percent. With CPI inflation declining to 2.33 percent in November and Repo at 6.5 percent, the real interest rate is way too high. Therefore, the central bank, particularly with its new chief, is likely to move to neutral stance in the February policy and might turn accommodative soon if growth continues to be weak. The softening of the bond yield (the 10-year is at 7.32 percent as I write) is clearly indicating this emerging monetary scenario. This is positive for markets.

Crude crash will be a strong tail wind for the economy and market

The growth scare in the global economy has already impacted the crude price.The US slowdown, along with decelerating Chinese economy and increasing shale supplies from the US will put a firm lid on crude price and may even trigger further fall in crude price. Though this is a negative for international trade and global growth, it is a major tailwind for the Indian economy and stock market.

Populism is an area of concern

 The recent spate of farm loan waivers is an issue of serious concern. This can degenerate into competitive populism and a ‘race to the bottom’. The stark reality is that we don’t have the fiscal space for loan waivers. Moreover, loan waiver is a sub-optimal solution to the rural crisis. India’s rural crisis has its genesis in surplus production. We have to move away from ‘management of shortages’ to ‘management of surpluses’. Unfortunately good politics is turning out o be bad economics.

Earnings growth likely to spurt in FY 20

Projections of earnings growth have been consistently proved wrong during the last four years. The huge losses of PSU banks, the miserable performance of telecom and aviation and the woes of the metal segment contributed to this lackluster performance. Excess capacity in manufacturing constrained private investment. Now, there is some light at the end of the tunnel. The huge losses of the PSU Banks are likely to turn to profits for the FY 2019-20 making a big difference to profit growth and Nifty earnings growth in FY20. The 12 percent depreciation in INR will boost around 40 percent of Nifty earnings. Capacity utilization in manufacturing has improved to above 76 percent and once this reaches 80 percent it will lead to smart pick up in private capex. The Q2 results of capital goods majors like L&T, Siemens, ABB and Cummins indicate smart pick up in order inflows indicating revival of capex. All these point to a smart pick up in earnings growth in FY20.

Politics will have only short-term impact

The political scene has turned unpredictable after the recent State elections. Presently, there is no clarity on the 2019 Central election outcome. It is important to appreciate the fact that in the long run election outcomes are not very significant. In India, coalition governments have delivered superior growth. If the election outcome is a shaky coalition government, that can turn out to be short-term disruptive for the market. But eventually, the market will find its own level and will be driven by earnings growth.

Profit from volatility

In 2017, globally, stock markets were unusually stable. 2018 proved to be very volatile. Going forward, in the coming months, this volatility is likely to continue, even aggravate, given the unclear political landscape in India. The bright prospects for earnings growth in FY20 have made valuations fair. Further dips in the market, triggered by internal or external factors, will make valuations attractive. Investors can profit from this volatility.

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