The India growth story has been on a roll for the last five years. The Government’s firm commitment to spur the infrastructure investment cycle is already reflecting in improved execution on the ground. Focus on rural incomes and spend is also helping broad-basing growth and serves as a long-term driver of the consumption story. The stress in the banking system has seen significant and targeted addressing, as expected, with recognition, provision of bad loans, resolution and subsequent capitalization. The Government has been laying the foundations for the road to sustainable growth through broader reforms and efficient administration. Growth will be spurred by strong infra related spend, urban consumption, rising rural incomes and improved demand going forward with the bottom behind us clearly. The uptrend in corporate results and earnings trend has been gathering steam since the second half of FY18.
Softer than historic inflation and better growth will gradually lead to a shift in the saving pattern of Indian households from physical to financial with a sharp bias towards equity. Corporate earnings are moving into a double digit growth trajectory driven by the domestic recovery.
In the medium term, India, with its twin deficits reasonably managed, lower base levels of inflation and improving corporate growth, stands taller than the rest of the EM pack. With the ongoing correction in the broad markets – more severe in small and mid caps – valuations are getting more comfortable than before with PE multiples tending to long term averages and lower. Mid and small cap stocks are close to their long term averages in terms of valuation and are at discount to large caps.
Domestic liquidity continues to be strong and we would keep faith in the corporate earnings recovery and look ahead into forward valuations of FY20 and beyond. State and Central election outcomes could create some short-term weakness in markets as also the noises on the trade war front. Near term, Indian markets may undergo a time consolidation or be range bound, which could be a good time to get invested in a disciplined manner. Every bull market is interspersed with both time and value corrections while reasons could be varied. Every point of volatility would be an opportunity to buy India. With every turn of the markets, the India-differentiation story gathers more interest, momentum and conviction in that order. We continue to remain positive on our equity markets with a medium to long-term outlook.
Coming to the issues that have been playing out in the last few months, pushing the markets lower, the credit event at IL&FS and the resultant possibility of a contagion in the bond markets led to a severe disruption of the markets. It appears that this has now been largely resolved with the Government stepping in to take control combined with the swift RBI action to infuse and maintain adequate liquidity in the system.
The other factors are economic like rising oil prices, depreciating currency, rising interest rates, trade war fallout and outcome of State and General elections. Most of these are, by and large, out of our control as they are mostly driven by global factors. However these are ‘normal’ cyclical economic events which have occurred in the past and will occur in the future. Economies, Companies and Governments have learned to adjust to these events and over a period of time these presently catastrophic looking events tend to become benign.
Our view is that markets will settle over time and until then one has to ride the volatility. To quote an oft repeated cliché be greedy when others are fearful’.
Current volatility is mainly driven by the following:
- IL&FS Default – With the Government take-over of the Board of IL&FS and related announcements it seems that the Government will ensure that there are no defaults. This should calm the debt markets over time and trading volumes should go back to normal which will greatly sooth the market sentiment.
- Increase in oil prices – likely to continue until there is more clarity on whether Iran sanctions will actually be implemented or not. Increase in production from other oil producing countries should help but eventually this may be determined by how much the global leaders can coerce alternate supplies. Finally, with the global growth stabilizing at higher levels of 3.5%, it is likely that oil will settle at a higher level (i.e. unlikely to go back to $ 40 levels) at about 70$, as the real driver for oil in the long term is the economy.
- Rising US Interest rates – Most emerging market currencies have been impacted by rising US interest rates as money moves out of emerging economies and into the US. However while data shows that US economy is fairly robust but that is on the back of tax cuts and these benefits will expire at the end of the year. This year growth is around 3% and consensus of next year around 2.5%. So, while there is optimism at this point of time, we believe that over the next few months we will see downward revisions to the growth expectation. One other reason to slow US growth is the trade war which is not ending soon as China is not backing off. There could be a prolonged tariff war which could impact US export and hamper US domestic growth, particularly the farm sector. So attractiveness of US will be little lower in the coming months and money will start flowing out.
- Current Account Deficit (CAD) and Rupee depreciation – The combination of rising US yields, tightening liquidity and strengthening crude prices have resulted in strong $ outflows from equity and debt markets this fiscal year. This further has pushed the rupee to depreciate by about 15% in a short span of time. Considering the points made earlier on crude prices, US growth and the attractiveness of India from FDI players, we believe that the currency should stabilize within +/- 1% to 2% from current levels. US growth is likely to peak off next year which will see some strength coming back into other currencies including the Rupee. We don’t see a substantial decline from here.
- Domestic inflation – Inflation expectation is moving up driven by oil price. While we have enough cushion on food prices, we believe over the next 3 months inflation can move up a little bit. Broadly we should be in comfort-zone of the RBI’s target of 4.5% or lesser. However the market is likely to react negatively if there is a change in RBI’s stance suggesting either an increase in inflation / move to a tighter liquidity.
- Outcome of State and General election: This is obviously not predictable. However elections over the long term have not had a lasting effect on the markets.
- Challenges and Opportunities for the Retail Investor: Corrections like these reiterates the importance of the basics of financial planning and investing which is risk profiling and having an asset allocation suitable to the risk profile.
Investors during bull markets tend to get carried away and imagine they are capable of taking more risk than they are capable of only to be rudely awakened when markets correct. The role of the Financial Adviser becomes critical in terms of anchoring investors to reality and reminding them that the equity market by nature is very volatile and ensuring that the portfolio is suitable to the risk profile and long term objectives of the investor.
The importance of re-balancing cannot be over stressed – a properly allocated portfolio, re-balanced regularly would be in a much superior position to ride market volatility.
So the challenge and opportunity for the retail investor as always continues to be two fold – having a suitable asset allocation and tactically increasing equity exposure when markets are falling.
Here again the Financial Adviser has a crucial role to play in being able to not only comfort the investor when the markets are falling but also to make him overcome his natural reluctance to invest in such a market.
Those who are able to overcome our inherent emotions of fear and greed and are able to be contrarian are the ones who will make real wealth over the long term.
SIP’s continue to be the ideal investment vehicle as it takes out timing from the investment process and averages the costs in times of sharp market corrections like at the present time.
‘Be greedy when others are fearful’.