At the outset, stable political mandate and likely continuation of economic reforms are a significant positive for capital markets. Given slower growth in developed world and ongoing trade disagreements between US and China, importance of the same is higher. It provides stronger reason for FIIs to look at India allocation positively as well as businesses can look at predictable environment domestically.
On the other hand, we have witnessed a mixed bag in terms of economic indicators. There is a noticeable slowdown in auto sector since September-December 2018. We are seeing a soft patch in consumer staples consumption from January. India also witnessed turmoil in the NBFC sector. Very large housing finance and infrastructure lending NBFCs faced acute crisis. Balance sheets supported with short term liability became unsustainable. Although it didn’t lead to any contagion across the financial sector as players with stronger balance sheet and older vintage actually gained from the crisis, it has affected demand in the sectors like auto, residential real estate, under construction commercial real estate projects and also wholesale trade segment. Slowdown is a combined effect of NBFC-led credit squeeze, consumption coming off from high base and softer macro-economic growth phase. Anecdotally, investment and large ticket consumption decision were also deferred due to general elections.
Rural demand issues are a real concern. India’s food price inflation fell significantly post demonetization. Farm incomes have diverged from the rest of the economy. Difference in nominal GDP growth with agri sector ~2% (good approximation of farmer income; not farm wages) and non-agri sectors ~13% is stark. Farm wage growth fell below 5% in 2018. Construction activity as a share of GDP is lower than pre-FY12 levels implying low opportunity for rural India to diversify out of the income stress. Investment rate has been running lower than FY12 peak, which means slower pace of job creation and therefore lower sustainable consumption growth trajectory.
Having discussed near term issues, from long-term fundamentals point of view, India will remain one of the fastest growing economy and its favorable demographics should continue to support growth. As GDP grows, per capita GDP will reach nearer to critical size. As witnessed in other emerging markets, consumption pattern will take different path from thereon. We are also bullish on long-term theme of financialization of savings.
We expect valuations for Indian companies to remain at premium vis-à-vis other emerging markets, given the strong GDP growth and earnings growth. Expensive valuation of quality companies is clearly a concern. However, over a period of time as the earning growth comes through, valuations will start normalizing.
We are focusing on technology and tax reforms as trends which are expected to significantly impact business landscape in India. There are opportunities to benefit from these major trends. We have a clearly articulated investment framework which emphasises on avoiding unsustainable businesses and companies with corporate governance issues. We prefer businesses, which are scalable, have clear competitive advantage and capital efficiency. This is where the wealth gets created over a long term. Having selected such businesses, we try to avoid overpaying for the same. While we track macros like interest rates, we treat them as a risk factor.
For an investor, understanding of her/his investment horizon, risk taking ability and risk appetite is important. This is an important step to figure out optimal asset allocation. For an investor scoring high on the above factors, it is advisable to predominantly allocate capital to equity. He/she should also recalibrate the allocation as these factors change over a period.
To summarize, we believe reasons for being constructive on investment opportunities from a long-term point of view far outweighs the negatives. Stable political mandate is a clear positive. While the concerns about slower growth globally, trade war and slower domestic growth are valid, long-term domestic fundamentals are strong. We are also positive on reforms, which will aid the strong fundamentals. At the same time, disciplined investment framework is important for longer- term wealth creation.
