Market had a solid bounce in September due to sharp cut in corporate tax, aimed at boosting investment and confidence of private sector. In October it was undergoing a short correction as earnings growth did not start in-spite of the tax cut and other stimulus announced by the government. Post the rally, valuation reached the roof while domestic and FIIs inflows reduced (except MFs) due to headwinds in Indian banking sector and concerns in the global market. Economic data are still weak, while RBI downgraded GDP growth from 7.1% to 6.1% for FY20. This phase of economic and market consolidation can stay in the short-term. While recent positive vibes on global trade talks, Brexit and optimism that domestic consumption will kick-off from H2FY20 onwards is playing a positive role today and in the latter part of the year. We suggest to stay calm with a watchful outlook on equity market. A well-diversified portfolio with a mix of quality names, Bonds and Gold assets is the way forward. This portfolio can easily soak short-term pain with a stable return and arise for long-term gains with switching strategy.
A short-term consolidation after the sharp climb…
The downside risk of the market reduced post the huge cut in corporate tax of ~10% for existing entities and ~18% for new investments. The key factors for the correction in mid October are:
- PAT growth has not yet started in-spite of cut in tax due to substantial fall in business.
- Valuation has increased post the rally of September Nifty 50 one year forward P/E is 18x compared to high of 19x.
- Market is concerned about fiscal position post the cut in corporate tax, contemplating that the original target of 3.3% can dilute to 3.9% due to loss of Rs1.45 lac cr in corporate tax revenue for FY20. This can escalate to higher public debt and interest rate in the future, unless the govternment manages to get income from other sources.
- Huge downgrade in GDP forecast by RBI and other institutions.
- Lack of incentives to invest in equites which is seen as a growth asset.
Post the tax cut announcement Nifty 50, Nifty Midcap and Nifty Smallcap rose by 10% very fast, factoring ~10% hike in EPS during the year. Post which market started consolidating losing about 1/2 of Large cap and 3/4th of Mid and Small caps gains, given weak economic data as mentioned above.
Please note that this tax measure will not have an extra benefit for mid and small caps; it will be beneficial only for companies in high tax bracket. Large-caps will have higher benefit since they are immediate beneficiary of improvement in economic activities and have the ability to come up with new investments given strong cash-flows. Government has been working well to overcome the economic slowdown. And to see a faster recovery, we need to bring normality in the financial system of the country. A quick remedy is needed regarding IL&FS and similar type of other issues, NBFCs and housing finance, NPAs of PSUBs and smooth working of the GST system.
The outlook for economy is weak in the short-term…
India’s real GDP growth is expected to slide to a seven year low of 6% in FY20. RBI, which had projected India’s real GDP to grow by 7.2% at the start of the fiscal, has scaled down its forecast to 6.1% during the last six months. Many international institutions too have substantially revised downward their forecast for India, the worst being 5.8% by Moody’s.
Growth had started to slow down two years back due to global factors. The impact got bigger this year due to sharp deceleration in domestic demand in consumption and investment. Latest data shows job cuts in industries, particularly in auto, textiles and gems and jewelry. Business environment has got unfavorable, as investment is hit by disinterest in capex due to policy issues and weak consumption. Capital investment by government has weakened due to its fiscal constraints. Government expenditure rose by 9.8% to Rs.11.8 trillion during April-August 2019. Revenue expenditure increased by 10.7%, while capital expenditure rose by a mere 3%. The government is likely to have a huge shortfall in tax revenue from fall in corporate tax and GST and they are planning to rectify this fiscal position by increasing non-tax revenue, through extra dividend from RBI and PSU’s as well as divestment through strategic sale of BPCL, BEML, SCI, Concor, others and tranches of Bharat 22 ETF. Anyways, it is going to be a mammoth task to achieve this fiscal balance. No clear direction from the government and sticking with the last fiscal target, has created a vague situation hurting the sentiment of the bond market, but government is likely to further cut interest rate in future hoping better fiscal management.
Government had cut the effective corporate tax rate, with a hope that corporates will invest the savings in future capacities. However, it seems that most of the corporates will distribute these gains to the shareholders through dividends. They are unlikely to start investing till they see clear signs of improvement in consumer and export demand.
FYQ2 earnings growth is likely to be muted…
Even after factoring the benefit of ~10% reduction in corporate tax rate in Q2, Nifty 50 preview shows flattish PAT growth of just 1% on YoY and 6% on QoQ basis. This is due to significant de-growth in auto, metal and telecom sectors. Finance, cement and pharma are expected to do better this quarter due to weak Q2 last year as a result of NPA problem, reduction in cement prices and price erosion in US pharma market. The strong performance in the Banking and NBFC is led by improvement in credit off-take and net-interest margin. Rise in cement prices and lower fuel costs are expected to benefit large cement companies. However, volumes are expected to be flat owing to economic slowdown and floods in different parts of the country. The pharma sector is expected to do better on account of price hikes in domestic market and lower price erosion in the U.S market.
The woes in the auto sector are expected to continue by lower consumer demand and bloated inventory. A combination of low commodity prices, weak demand, and above-normal monsoon is impacting metal companies. The I.T sector is expected to report muted earnings growth due to external macro challenges and increase in employee cost. Currently, sectors like Pharma and IT slid by 11% and 5% respectively. The global trade uncertainties are impacting whole export-oriented sectors in which increased US FDA observations pulled pharma down whereas lower deal wins in BFSI segment and wage hike is impacting IT stocks. The recent corporate tax cut won’t make much difference to their earnings outlook as the effective tax rate of most IT and Pharma companies are either below or at par with the new tax rate.
Short-term trend could be tepid but will improve from H2FY20…
Earning expectations had improved post the corporate tax cut, but we are bearing downgrade in EPS growth, in the short-term. GDP growth is expected to recover to 7.0% and 7.5% in 2021 and 2022, respectively, while EPS growth will start to improve from H2FY20 onwards. A careful trend is expected to continue in the equity market during the short-term, while expectation builds-up for FY21 led by start of capex, FDI and private consumption.
The broad economy will take some time to gain and invest in new projects. We can expect a slow U shape recovery since we need both an improvement in world exports which is not visible today and removal of blockages in our domestic financial market. Having said that the worst for domestic economy may be over by Q2 – Q3 FY20. We can expect a faster recovery in consumption led by stability in job market, festive seasons and reduction in interest cost. This quick benefit cannot be replicated in non-consumer segment as financial sector and new investments will have a lag-effect. The equity market may trade with a mixed bias in the short-term. We expect the broad market to maintain its positive bias in the long-term, and 11,200 to 11,500 to hold a strong support for Nifty 50 in the short-term.
The recent developments are very positive for equity market…
We had three key reasons impacting the global economy and market: US-China trade talks, Brexit and geo-political issues. We are hearing positive developments regarding trade wars and deal with UK and EU. World economy was slowing down due to concerns over trade and new investment. This hangover is going to reduce as a final deal is reached between the parties. FII’s view will change from negative to positive on emerging markets and inflows will grow better.
In India, Government’s intention to correct the economic situation with tax and stimulus measures is positive. And the statement to provide further fiscal stimulus in the future as per the need of the economy is lifting the sentiment of the market. Risk taking ability for equity investment is improving in the market with optimism over recovery in the economy led by stimulus, festive demand, good monsoon and lower interest rate. The start to Q2 result for the broad market has been mixed while for banking sector it has been marginally better led by base effect and reduction in provisioning. The outlook has improved with reduction in NPA problem and operational cost. The negativity is that slippages are still happening but given attractive valuation and resolution in the future, the banking sector is expected to do well and outperform the market.
All the negative factors of the Indian economy are known and expressed in the weak outlook forecast. Today, consensus is deeply negative regarding the economy and equity market. It seems that all the issues of the economy are largely factored across the board. But the equity market has been lackluster in the last 1.5 year with no real growth in value. It is time for equity market to do better in the coming period as the worst may be factored in the reality.