This market has turned into a voting machine; so listen to Benjamin Graham
- During 2014-2017, bulk of market returns came from PE expansion.
- Dovishness of global central banks will be beneficial for EMs.
- The Interim Budget was a balanced one and expansionary in nature.
The Interim Budget was a balanced one and expansionary in nature: It was a pragmatic budget, benefiting various sections — be it farmers, middle class or the unorganised sector. For small and marginal farmers, the government announced a direct income support scheme, besides offering interest subvention benefit on loans. Various tax sops were announced for the middle class, including full tax rebate for individuals having taxable income up to Rs 5 lakh per annum. This will leave more disposable income in the hands of these individuals and help boost consumption to some extent (esp. for low-ticket items). All of this makes the budget a bit expansionary in nature. Also, a mega pension scheme was announced for the unorganised sector, which is poised to become one of the largest pension schemes in the world, in the coming years.
With these various schemes and sops, there has been some fiscal slippage for FY20 to 3.4 per cent of GDP (compared with 3.1 per cent earlier). As a result, we have seen a higher than expected government borrowing programme, which had put some moderate upward pressure on bond yields.
Tax buoyancy continues, with the tax-to-GDP ratio expected to rise further. On the revenue front, budgeted net tax revenue growth has been projected to be healthy at ~15 per cent YoY in FY20, and appears to be reasonable. The share of direct taxes in overall tax revenue has been rising over the past few years. Capital receipts growth is also expected to pick up. On the expenses side, revenue expenditure growth is budgeted to rise 14 per cent YoY, while capital expenditure growth is likely to slow down to 6 per cent YoY in FY20 (BE) from 20 per cent YoY growth in FY19 (RE). The slowdown in capex growth is probably due to fiscal constraints; however, certain major ministries like railways, roads & highways and coal sectors still received healthy allocations for FY20.
The government is also depending on healthy dividend especially from RBI, although divestment revenue collections (budgeted at Rs 90,000 crore in FY20) will depend on market conditions.
RBI policy was more dovish than expected
RBI cut rates and changed its policy stance in its February 2019 policy review. Also, the central bank further cut forecasts for inflation in this policy, after cutting them in the December policy. The RBI governor has not ruled out further rate cuts, and said it will be data-driven. Overall, we feel RBI’s focus has changed from inflation primarily, to a combination of inflation and growth support, considering that price stability has been achieved, and inflation is currently well below the official targets.
Even though inflation has been well under control, some concerns still remain on the fiscal front for FY20, and higher bond supply. Further, there could also be some pressure on yields if there is a liquidity and credit crunch, or any further rise in crude oil prices. Therefore, on the fixed income side, we continue to prefer the shorter to medium term part of the yield curve.
Corporate earnings growth expected to accelerate
Corporate earnings for Q3 FY19 so far has broadly been in line with expectations, and the upgrade-to-downgrade ratio has been better than that in the previous quarter. We expect corporate earnings growth to accelerate going forward (particularly in FY20), and we believe that will be the key driver for markets going ahead.
Earnings growth over the past few years was primarily driven by domestic consumption sectors, but we expect that growth will be more broadbased in 2019, and also that the capex cycle (which has been a drag earlier) has now bottomed out. Gross fixed capital formation (GFCF) or Investments, as a percentage of GDP, have bottomed out and been recovering. Also, capacity utilisation is picking up, and is reaching more optimum levels, and we expect the capex cycle to recover gradually post the general elections.
Even though in the Interim Budget capex growth (of govt.) is budgeted to slow down in FY20, we could see private capex (which has been lagging for a while) pick up going forward.
Valuations have become more reasonable
Over the past few years (2014-2017), bulk of the market returns have come from PE expansion, and a relatively smaller portion from earnings growth. This had made valuations elevated, especially in the midcap and smallcap segments, where market returns have been relatively higher over the period. However, over the past year, corporate earnings growth has been recovering, and the headline index returns have been flat, while the smallcap & midcap segments have seen a significant correction in prices.
As a result of this, there has been some PE compression, and valuations have become more reasonable, and trading near the long-term averages. The significant valuation premium that smallcaps/midcaps were trading at (versus large-caps), has also come down over the past year, with the correction. We recommend investors a mixed exposure to largecap and midcap segments, with preference and higher allocation to the former — on a relative valuation basis.
Global factors also influencing markets
Recently, the US Fed turned dovish, and that is being reflected in some softness in US and global bond yields. Further dovishness in monetary policy of major global central banks will be beneficial for emerging markets (including India), and we have recently seen a pick-up in flows in emerging market ETFs particularly.
Also, global markets bounced backed smartly in CY2019 (so far), after seeing a healthy correction in late 2018. Although, India was among the top performing markets globally last year (in CY 2018), it has been a relative underperformer so far in 2019.
An eye needs to be kept on the US-China trade tariff developments, and on the expected slowdown in global growth in 2019, as it may have an impact on global risk appetite.
NBFC & Liquidity crisis behind us
The NBFC / HFC space has recovered somewhat from the liquidity & credit crunch post the IL&FS default, but liquidity conditions still remain a bit tight in this segment. One comforting factor is that RBI has been supporting on the liquidity front through OMO purchases, and recently RBI governor commented that the central bank is ready to support (on the liquidity front), if there is any constraint.
However, this is an evolving situation, and any other credit events could further put pressure on liquidity, especially with the seasonal liquidity tightness typically seen during the financial year closing period. Mutual funds (a key source of funds to the sector) have reduced some NBFC / HFC exposure in their debt portfolios over the past few months, and we feel that some of the incremental credit growth in NBFC/HFCs seen in the past will slow down, and get partially transferred to banks going forward.
The recent announcement of removing three PSU banks from PCA norms or any further action in this space, will continue to support credit growth for banks. Overall, even if there is again any liquidity crunch for NBFCs, we feel that the well capitalized and prudent NBFCs will be less affected, and continue to grow.
As an end note, you may have noticed a sign on side mirrors of cars, saying that – ‘Objects in the mirror are closer than they appear’. To draw reference, there can be a lot of events that impact the market in the short term; create noise, and cause volatility. However, an investor needs to be forward-looking, and over the long term, fundamentals primarily weigh in on the markets.
Studies have shown market returns typically track corporate earnings growth or nominal GDP growth in the long term (both of which are recovering in India), even though there may be some intermittent deviations in the short term.
As the famous quote by Benjamin Graham goes – “In the short term, the market is like a voting machine, but in the long term it is like a weighing machine.”