Investors in India should tighten their seat belts so that they can withstand the likely market volatility in the first half of 2019 – when elections are scheduled – and enjoy the earnings recovery ride in the second half and beyond through bottom-up selection.
2018 was more or less in line with our expectations: the micro economy recovered from the teething issues related to the implementation of the goods and services tax (GST) and demonetisation-led shocks, with consumption picking up and government spending accelerating. At the same time, India’s macroeconomic variables declined marginally from the unsustainably lofty levels of 2017.
In 2018, equity markets were volatile. While this was expected, the sharp correction in mid and small capitalisation companies was not. Interest rates rose as anticipated, and the 10-year government bond yield reached 8%. On the other hand, slower-than-expected earnings growth disappointed us. While top-line growth was in line with our expectations, the growth in profits also disappointed.
2019: a tale of two halves
We expect the first half of 2019 to see numerous events that will likely keep financial markets more focused on macroeconomic factors. Conversely, we foresee microeconomic variables taking centre stage in the second half, making stock selection a critical component in seeking outperformance both in equity and fixed-income portfolios.
In our view, among the many influential events in the first six months of this year, there will be four principal ones to watch out for.
- The US Federal Reserve’s monetary policy stance: the focus will mainly be on the pace at which rates are being raised (two rate increases indicated, as per the latest Fed meeting) and the pace of balance sheet unwinding.
- The US-China trade dispute: this could have a bearing on large (as well as related smaller) economies – hurting their competitiveness, capital allocation, resources and economies of scale.
- Crude oil prices: this year we expect to see some certainty emerge around these. With OPEC+ production cuts and slower demand growth globally, crude prices might stabilise. This could help market participants and businesses make smarter decisions.
- The upcoming general elections: this will chalk the way forward for India over the next five years as it will determine which political party – and ideology – will be at the helm.
In the midst of such uncertainty, the underlying economy will likely remain in recovery mode. Over last four years, the economy has undergone the implementation of several ‘framework’ reforms which have caused short-term disruptions. However, we believe these initiatives are likely to bear fruit in the longer term, helping the economy achieve stronger, more robust growth. Consumption has recovered from the demonetisation-led shock and we believe it will continue to drive microeconomic growth, alongside the continued thrust from governments at both the state and central levels on infrastructure.
Be selective after the elections
In the second half, after the general elections, we expect the focus to return to the fundamentals. These six months should see careful stock selection rewarded as crucial variables such as the state of the global economy, stable crude prices and the new government’s economic policies could influence stock prices.
Our mandate would be to identify sectors and companies which can grow earnings sustainably and at a superior rate over the next few years. Similarly, when considering fixed income opportunities, we will have to make major decisions on duration and credit as these factors are likely to be the sources of the optimum risk/reward.
We believe India’s equity markets are poised to do fairly well amid likely volatility. Given that 2019 will be an election year, we cannot wish the volatility away; however, we believe that the earnings recovery, albeit delayed, will take centre stage after the elections.
- We continue to like consumer-oriented companies given their superior growth, positive cash flows, minimal debt and substantial moat.
- Banking, especially corporate banks, could provide profitable growth as their asset quality improves, while retail lending should provide future growth and fee income opportunities.
- Infrastructure, unlike the last few years, is expected to see some traction and thus could provide opportunities for stock pickers.
- However, we believe any recovery in exports will continue to remain choppy amid non-tariff barriers and slower global growth.
Source: RIMES, MSCI, IBES, Consensus Estimates. Data as of Jan 2019. FY – Financial year ending March
On the macroeconomic front, benign inflation, lower crude oil prices, a dovish US Federal Reserve and an expected change in the Reserve Bank of India’s policy stance to neutral bode well for GDP growth and the fiscal balance. We believe this, supported by the central bank’s liquidity easing measures (open market operations) and the government keeping to its fiscal deficit target, could keep the benchmark bond yield in the trading range of 7.10% to 7.40% in the first half of CY 2019. However, the direction of crude oil prices and the outcome of the election will most likely determine the range in the second half.
To summarise, we expect the first half of CY 2019 to be a ‘macro over micro’ environment and the second half to be a ‘micro over macro’ environment.