Market sentiment has been weak in the last four months, till the announcement of big cut in corporate tax, 20th September Nifty50 had fallen by 12% from a high of ~12,100 on 3rd June to a low of ~10,640 on 23rd August. In the last two months, market was consistently trading below the 200 daily moving average, and hovering within a narrow range of 10,650 to 11,100. It was trading in this thin margin because, market was waiting to know and understand the global and domestic developments which was being worked-on to eliminate the slowing economy. The unexpected cut in tax rates by ~10 for existing entities and ~20% for new investments has changed the negative bias. Given the risk averse mode, we had a conservative view on the market with a target of 11,600 for Nifty50. But post this big change, we are increasing the FY20E expected EPS growth to 18% from 10% for Nifty50. We also increase our one-year target for Nifty50 to 12,500 valuing at 17.5x one-year-forward P/E.
The initial three domestic stimulus announcements did not improve the sentiments of the economy…
The first economic stimulus was taken positively by the market, which expressed the government’s concern about the slowing economy and plans to work-on it going forward. It had both supportive and corrective measures like reversal of FPI’s surcharge, speedy recap of public banks by Rs70,000cr, additional support to housing finance by Rs20,000cr, tax relief to startups, payment of GST refunds to MSMEs, additional depreciation of 15% for buying new vehicles and lifting of ban on the purchase of new vehicle by government to replace old ones. FM also indicated that they will announce two more such plans to revive the economy. And the market was eagerly waiting to know about the upcoming steps and its implication on the economy with a positive bias. Well, after few days, the second announcement was made regarding PSUBs consolidation. However, it had no real effect in the market, since it did not provide any add-on package to the slowing economy rather an extension to the first announcement. The third announcement was more towards uplifting exports, housing finance and others. In order to see an immediate boost in exports, firstly, the world economy has to improve. Secondly, it will have a lag benefit since it is likely to be implemented only by January 2020. Regarding the housing sector, the incentive was targeted towards affordable housing which is not the problem area today but luxury segment.
Overall these announcements did not completely change the sentiment of the market since they did not address the slowing economy in the short-term. For immediate benefits we needed fiscal expenditure as monetary policy will take time to affect the economy. Having said that all these measures will have a multiplier effect on the economy in the medium to long-term as the economy stabilises. Given the short-term issues, the market was evading these announcements and moving negatively in accordance with the momentum of the global market and weak domestic economic data.
The latest economic data was weak, with the GDP growth of 5% having a bad effect on the market. They were well below the market expectation and increased the risk of further downside in economic growth. The data also stated that the economy will take more time to revamp in spite of the supportive measures announced by the government. We will need more supportive measures from the government like higher spending and stimulus to industries. Besides other important economic data like Q1 earnings growth, wholesale inflation, auto sales and depreciation in INR are not helping the market
Market was anticipating for moderate improvement in the Indian economy by the third quarter of FY20 led by stability in the country’s financial liquidity as NBFCs and PSUB recover from the NPA issue, increased government spending, good monsoon, demand from festival seasons and reduction in interest rate. For a strong recovery, we need an improvement in exports which is currently stuck under trade-war, Brexit, high bond yield and geo-political issues.
A complete change in sentiment led by improved earnings outlook…
Global market has found some positive momentum in expectation of resumption of trade talks between US-China and quantitative easing by ECB. This global outlook is short-term in nature as foreign investors continue to be cautious with a risk-off mode due to uncertainties in global market followed by high volatility in global bond yield.
But in the domestic market the sentiment has changed a lot led by strong improvement in earnings growth, post the corporate tax cut plan. In spite of all these, we expect that the muted economic growth and fiscal pain will continue in FY20. Cut in corporate tax will not bring an immediate push in the macro gauge as fiscal deficit will increase from targeted 3.3% to 4.0% in FY20, due to loss of Rs1.45lac cr. tax revenue, thereby increasing the risk of increased government borrowing and interest rate. But this will improve the micro factors in the economy led by the fiscal stimulus, encourage job generation, increase profitability and disposable personal income, bring new projects and add competitive advantage among Asian peers to garner gains from globalisation and make in India. Effective tax rate is reduced from ~35% to ~25% for existing businesses and ~17% for new entities. The resultant advantage is going to play for the long-term and secure a high growth in the economy. This will in turn reduce the country risk and provide premium valuation for equity market.
Given a deep correction in small and midcap in the last 1.5years due to slowdown in domestic and global economy, disruption in system liquidity, structural, cyclical and policy changes, the valuation and prices of these classes of equity bended down below the long-term trend. NSE Midcap100 and NSE Smallcap100 indices are also down by 30% and 45% respectively. The one year forward P/E stands at 14.5x and 13x which is about 10% below the 5year average respectively, with an all-time high of 25x and 19x (Bloomberg). We therefore advise our clients to make room for mid and small caps in their portfolio. We have marginally increased the mix of mid and small cap in Geojit Equity Model Portfolio (please see the detailed model portfolio included ahead) to 17.5%. A majority is still allocated towards large-cap at 75% while 7.5% is towards Goldbees. But we see a possibility to increase the mix of small and mid-cap in the future, which will be stock specific.
The equity market may trade with a mild negative bias in the short-term due to sudden push in prices. But we expect the broad market to maintain its positive bias in the long-term, with 11,300 likely to be a strong support for Nifty50 in the medium to long-term. However, we don’t expect a V shape recovery in the economy and market. Having said that there is a chance that the worst for the GDP growth will be over by Q2 – Q3 FY20. We had a conservative view on the market and cut the target of Nifty50 to 11,600 post the weak Q1FY20 results and economic data, but today we are changing that view. We therefore increase the EPS growth for FY20 from 10% to 18% and maintain 15% for FY21 and FY22. This leads to an EPS of Rs580, Rs668 and Rs768 for FY20, FY21 and FY22 respectively. We value at one-year-forward P/E of 17.5x on one-year-forward EPS of Rs716 to arrive at target of 12,500 for Nifty50.