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Market outlook: Presentation on equity markets
Publish Date: 15th June, 2018
By: Rusmik Oza
The four pillars of the Indian equity markets are:
- Macros
- Flows
- Earnings
- Valuation
The Indian markets have changed to moderate to weak macros due to higher fiscal deficit, infla-tion and current account deficit.
On the brighter side, foreign investors continue to invest in India as the GDP registered a healthy 7.3% and IIP (production index) remained stable.
Domestic macros
- May CPI has firmed up further to 4.87%. Core inflation is at 6%.
- RBI hiked the borrowing rates for the first time since 2014. We expect another rate hike in Au-gust.
- Need to watch out for MSP hike as the government had indicated in the budget that they in-tend to increase farmers’ compensation.
- IIP at 4.9% aided by 13% (YoY) growth in capital goods production.
- Current account deficit stood at 1.9% in the fourth quarter of FY2018. Although it is not as high as it was about five years back, this
remains a concern.- Rupee to remain weak in FY2019 if crude prices remain high.
- Expect monsoon to be normal, which augurs well for the auto, FMCG and agrochemical sec-tors.
- Government spending may be ramped up because it has to finish certain projects before the election.
Global macros
- US economy remains strong. Unemployment at low levels.
- Fed rate hikes. Negative for foreign fund flow into emerging markets.
- European Central Bank — rollback of QE (quantitative easing) program. This is negative for the emerging markets.
- Crude continues to remain at elevated levels at 76%, which is 17% higher (YoY).
- Trade-related issues between China/European Union and the US.
- On the positive side, geopolitical issues are mitigating, especially the improvement in US-North Korea bilateral relations.
Micros: Mixed, but improving
- IIP has started improving. Could go up.
- Commercial vehicle numbers could go up
- Service sector is likely to improve too
Flows: Mixed bag
- Mutual fund inflows remain strong at $8.8 billion. Strong SIP flows have contributed to the strong inflows.
- FII inflows have been very poor due to global headwinds such rising food prices etc. This is a stark difference from previous year when
both MF and FII inflows were strong. However, this could be good because there was about $9 billion SIP inflow from the domestic side.
- Compared to other emerging markets, India has performed well.
Earnings: Aggressive future estimates
- Earnings in the last couple of years were disappointing due to GST. But we believe there will be a 23% earnings growth in FY2019 and
19% growth in FY2020 on Nifty.- They seem to be on the higher side but they are working on last year’s low base.
- Similar, RoE’s will be healthy too. RoEs were 12.7% in FY2018, but we expect it be more than 15% in FY2019.
Valuations: Global comparison
- India looks expensive on absolute and relative basis, a trend that’s been observed for a few years now.
- Nifty valuation remain high. They are trading at 18x. They are rich valuations but they are not in a bubble zone. We feel they’d be in a
bible zone if they are trading at more than 22x.- Bond yields are higher than earnings yield. They are at 8% right now. This puts equity market valuations at risk.
- Midcap valuations have historically been lower than Nifty valuations. That’s because of strong inflows from the local side have resulted in
the midcaps receiving more money. However, we do no think that will sustain. In the past, such situations have often resulted in a
correction in the midcap valuation.Investment strategy
- Returns to be based on earnings growth rather than PE expansion
- Several midcaps have corrected in the last two months due to additional surveillance
- Need to be very selective while choosing midcaps
- Focus on good management, superior earnings growth and reasonable valuations. That’s be-cause there may political uncertainties in
the coming months.- Apportion larger allocation towards large caps, that too on the safer names
- Preferred sectors: Automobiles, pharmaceuticals, agro chemicals, housing finance, metals, infra and construction
Stocks: Research recommendations
Large caps: Tata Motors, Bajaj Auto, ITC, Castrol, Vedanta
Mid caps: Engineers India, Dilip Buildcon, Nagarjuna Construction
Small caps: Asian Granito, Time Technoplast, Jindal Stainless (Hisar), Dollar Industries, Every-day Industries, FIEM IndustriesQ&A
1) Pharma sector outlook: They have been underperforming but we see 20% upsides in the next one year. Sun Pharma, Cipla, Lupin and
Dr Reddy’s are good bets. It is better to stick to the bigger names.2) Tata Motors vs Ashok Leyland: Both are doing well on the domestic front. But Tata’s earn-ings could be double in the next couple of
years.3) Banks: Private banks are trading well, while we are waiting for more earnings clarity when it comes to PSU banks.
4) IT stocks: They have gone to the desired valuation. Buybacks also suggest that there are lim-ited opportunities. Overall revenue growth
may be muted.5) FMCG: Most of them are trading at peak valuations. ITC can be a good buy though.
6) Infrastructure: We are bullish about them, same with construction companies. Most of the companies should do well going forward.
Also read
- Other stock recommendations
- Our brokerage options
- 4 questions you may have about rupee depreciation
- How India Inc fared in Q1 FY2019
- Indian markets: Caught in the trade war crossfire
Disclaimer: Our research should not be considered as an advertisement or advice, professional or otherwise. The investor is requested to take into consideration all the risk factors including their financial condition, suitability to risk return profile and the like and take professional advice before investing. Full disclaimer here
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