The volatility seen in the equity markets in 2018 continued in January 2019 as well. On one hand, global macro concerns have moderated and sentiments for emerging markets were boosted after a dovish US Fed commentary. However, domestic equity market sentiments were impacted by a mixed Q3 FY19 reporting season and investor concerns in companies with perceived lapses in corporate governance.
The US Fed has signaled that it will not be raising rates for some time and that it would be flexible in its quantitative tapering program. This is a reversal from its earlier bias towards tighter monetary policy. With expectations of further rate hikes by the Fed having faded, the strength of the US Dollar should remain capped and this will be positive for emerging markets, including India. US and China are also continuing their negotiations on the trade front to seek a resolution by the end of February. Although, Brent crude prices have rallied 23% from their lows to USD 62.5 per barrel due to supply cuts by the OPEC+ coalition, US sanctions on Venezuela taking effect etc., they still remain within India’s comfort zone. Long term oil prices are being capped by slowing global growth and uncertainty over the US-China trade war. Brent crude oil prices are expected to be range-bound between USD 50-70 per barrel, which is positive for oil importing emerging economies like India. In light of these developments, emerging markets have continued to see positive inflows over the past month.
The rupee depreciated ~2% in January mainly in response to the rise in crude oil prices. However, India’s CAD is likely to moderate and external stability is less of a concern now. With inflation consistently undershooting estimates and well below the RBI’s target of 4%, the RBI can be expected to cut rates further this year. The Interim Budget announced by the government has provided a Rs. 1 lakh crore plus stimulus to the economy. Direct income support for farmers and tax benefit for the middle class will increase disposable income and benefit sectors like agrochemicals, agriculture inputs, consumer staples, small ticket consumer discretionary items like small appliances, retail, two-wheelers, housing finance companies, retail oriented banks, and NBFCs.
The Q3 earnings season is in progress. Two third of the Nifty50 companies have reported results so far, out of which, 75% have come in above or in-line versus estimates. Nifty companies have shown robust revenue growth, however operating margins and PAT have been under pressure as companies faced the full impact of rising material prices and energy cost, tightened liquidity, and higher interest cost. Select Private and Corporate Banks and NBFCs, IT, Infra and consumption-oriented companies reported decent set of numbers.
View on the market
While the large-cap Nifty index was flat in January, the mid-cap and small-cap indices declined ~5%.This is a continuation of what we saw in 2018, wherein the mid-cap and small-cap indices underperformed significantly. Unlike in 2017and 2018, the valuation for mid and small-cap companies are now at a substantial discount to their large-cap peers. It will be interesting to see how long the sentiment towards small-and-mid caps remains muted and how quickly they come back in favor of investors over the next one-year!
Considering today’s investor sentiment, there are clear signs of fatigue and heightened pessimism considering the broad-based correction in small and mid-cap stocks, where even companies witnessing improving business outlook have also corrected by more than 20%. However, one year back it was typical for a new company IPO to be over-subscribed by 100 times, in fact some have got subscribed 200x with hope of quick listing gains. This apart listed companies qualified institutional placements (QIPs) were getting hugely oversubscribed. Direct investment by high net worth individual (HNI) and leveraged equity investment was also at all-time high. In hindsight, one knows that the investors were gripped with fear of missing out which was not justified and hence the correction. I would like to share some data points to emphasize why we believe that the correction in midcaps is overdone and today’s pessimism may not be justified in the same way as the optimism at the beginning of 2018 was not justified. If one looks at the Nifty midcap index, over the last 16 years, it has delivered positive returns more than 75% of the time and negative returns less than 25% of the time. Also, it has been observed that after a sharp correction, the pullback has also been equally strong. The Nifty midcap index has appreciated by 30% to 60% in the 2 years following a correction of upto 20%. While after a fall of 30%, the midcap index has actually delivered more than 100% returns. For example, post the corrections in CY 2008 and 2011, the markets have bounced back strongly. This is not to say that one should expect similar upside this time also. However, if history is any indication, then this correction might be the time to buy or add more rather than worry about the near term challenges of general election outcome, global trade war, crude price movement etc., which might be already priced in.
Thank you and Happy Investing!
(Source: ABSLAMC Research, Bloomberg)