Inflation, weakening currency and rising oil prices are the biggest concerns
The Nifty 50 returned 9.1 per cent year-to-date (YTD) (as of August 14, 2018) and is showing mixed signals as we approach the end of the season for the quarter. Though macro indicators and earnings show positive signs, global instability, currency, and crude oil have been dictating the course of the market
In the last four years, we saw a stark rise in domestic participation in primary markets as well as equity mutual funds, with the Domestic Institutional Investors net inflow increasing by ~68 per cent YTD (as of August 13, 2018). We expect this trend to continue.
To add to the macro cheer, India’s June Index of Industrial Production beat estimates touching seven per cent from 3.9 per cent in May, indicating promising trends within consumer durables, capital and construction goods.
Meanwhile, as the impact of GST and demonetization wanes, we believe that corporate earnings have begun their revival journey with our analysis suggesting that 2,200 companies witnessed a 19 per cent year-on-year sales growth, the fastest in the last three years.
Crude oil prices have always been a pain for the Indian economy. Prices beyond $80-90 per barrel pose a serious hurdle as India imports ~80 per cent of its oil requirement, having repercussions on the twin deficits.
On the global front, we are witnessing escalating tariff wars and political tensions, the most recent being the standoff between Turkey and the US. The Lira has tumbled nearly 45 per cent against the dollar this year, leading to a contagion effect on other emerging markets.
The rupee also hit all-time lows beyond 70/$ this week. With India’s current account deficit and external debt/GDP positions being relatively better than other emerging marketss and forex reserves being greater than 2013 levels, we believe this effect will be limited. History has also shown us that through economic crises, Indian markets have been able bounce back with tremendous enthusiasm compared to other markets.
Although retail inflation has eased to 4.17 per cent in July against 5 per cent in June, core inflation is actually close to a four-year high. As rupee crosses the 70 mark, it does not bode well for inflation and current account deficit numbers. Despite that, it has been stronger compared to other emerging market currencies.
We believe that IT, pharma and textile industries will be the main beneficiaries of the currency depreciation, while oil marketing companies, cement, metal and power as well as companies with high commercial external borrowing may take a beating.
Bullish on IT, private banks and NBFCs
Within equities, markets are tending towards maturity, and the alpha that investors saw in large caps a few years ago may wane going forward.
Some mid-caps have plunged as much as a 50–60 per cent from their 52-week highs, with one-year forward multiples for BSE mid-cap corrected from 30x to 21x in July. The recent correction in mid and small caps may be seen as an opportunity to enter selective stocks from a long-term perspective for those seeking a greater risk/reward ratio. The Nifty Private Bank index jumped 15.6 per cent YTD (as of August 14, 2018), with private banks capturing a rising market share from debt-ridden state-run banks. Private bank valuations look stretched, though they may not see corrections in the near term, and may be available at attractive risk/reward ratios.
Against the backdrop of rising protectionism and financial vulnerabilities, investors will withdraw profits, going back to safe havens. Moreover, in the absence of a clear plan to stabilize things, Turkey like Argentina might go for a bailout.
Considering India’s position compared to other emerging markets, however, we believe that the Lira impact will be limited. Yet, India must deal with rising core inflation, as a weakening currency that is not competitive enough for exports and rising import bills.
In the near term, crude oil prices and global events will be key factors to watch out for. We advise investors to exercise caution when investing in equities in the near term and stick to sectors that are not heavily import dependent.
The author is Head of Research, IIFL Securities.