During an election year the capacity of the government to come out with reformist budget is limited, since the final budget will be announced by the new government. This time the current ruling party is under pressure to please the common man with populist measures given its declining state strength and slowing economic growth. Hence, they will attempt to share their long-term vision with friendly taxation and farmers’ schemes on or around the budget speech. It is possible that fiscal deficit can go up to 3.5% from the target of 3.3% for FY19 due to lower tax revenue and higher fiscal expenditures. But a good portion of this is factored by the market. A reduction in 10-year government bond yield from 8.2% to 7.3%, a 90bps cut could be an indicator that the gap in deficit is manageable in the future.
We feel that the current muted trend of the market during the last one year provides an opportunity to play on cyclical sectors. Capex oriented sectors will reverse post the election risk. A risk-averse investor can consider to have exposure in industrial sectors. We do not expect important measures to be announced in the interim budget specifically benefiting stocks and sectors, other than consumption-oriented sectors given the populist agenda. But this ongoing populist risk will reduce post the budget and election. As a result, rather than direct benefits, sectors like Oil Marketing Companies can experience a relief rally as the event or populist risk reduce. Infra, Capital Goods and Cements can also benefit if populist measures are not as bad as it is being feared by the market while outlook improves due to return of government capex. As per the history, budget has not impacted the long-term trend of the market or specific sectors. But this time due to fiscal deficit, slowdown in economy, populist schemes and reduction in government spending, industrial sectors like OMCs, Banks, Cement, Infrastructure and Capital Goods were negatively impacted. This trend will reverse as the businesses outlook normalize.
The start to Q3 result was lower than expected with subdued numbers from IT and Banks. While the recent results from blue chips like RIL, HUL, Wipro and HDFC Banks were better than expected. Based on results announced till date, 10 stocks in Nifty50 index, PAT growth on a YoY basis is 10% compared to line-in-line expectation of 5%. In total, market was expecting 1% growth in PAT for Nifty50 index stocks in Q3, till now it has twisted from negative to positive.
We believe that as the year matures we will have better investment opportunities to come. The main reasons for us to have a positive outlook are; Earnings growth will be better in FY20 especially in the second half compared to the subdued earnings in the last 3yrs due to a hose of reforms, which came one after another. We are likely to have a positive lag-effect in the economy from these reforms. Indian fiscal is at background for FY19 but overall it is still good compared to the history and will be better in FY20 with additional support coming from lower Oil prices. Inflation has been bought under control and will lead to lower interest rate in next 6 months. Relationship between RBI and the Government has improved and both are working towards improving the liquidity situation in the financial market. The pace of interest rate hike in the U.S. will normalize in the second half of 2019 as U.S. and China concluded the meeting to resolve the trade war issues on a positive note.
Posted on: January 24, 2019
