The month of September was a perfect storm for the equity markets. We saw increased volatility on the back of global macro factors such as rising oil prices, strong USD, and the trade war, as well as domestic factors such as tightening liquidity and default by a large financial institution. (Source: ABSLAMC Research)
Oil and fiscal deficit
Over the past 4 months, we have been reiterating that crude oil prices need to be in the US$ 55-65/bbl range for a stable macro-economic environment in India. However, Brent crude rallied by 6% in September due to tighter supply and reached a 4-year high of US$ 86/bbl. This is well above our comfort zone as every $10 rise in oil prices increases India’s CAD by 0.4% of GDP. In the next few months, oil prices are poised to remain elevated due to low OPEC spare capacity and lower-than-projected growth in US shale production. In order to give some relief to consumers from rising fuel prices, the government has resorted to excise duty cuts and price intervention. While this is a populist measure, the government has reiterated that it will not impact its commitment to maintain the fiscal deficit at 3.3% of GDP. However, we believe there is a risk of fiscal slippage by 0.2-0.3% due to lower GST collections, lower divestments, and higher MSP for farmers. (Source: Bloomberg, Financial Express, ABSLAMC Research)
The USD strengthened further in September as the Fed raised its benchmark rate by 25 bps on the back of strong US economic data. YTD, the INR has depreciated around 14% vs. the USD and has breached levels of 74/$. In comparison, currencies of other emerging markets (EMs) such as S. Africa, Russia and Brazil have also depreciated 14-17% YTD vs. the USD while the Chinese currency has depreciated more than 5%. Amidst global volatility, India is relatively better placed than other EMs as it is a high-growth economy driven by domestic demand, has sufficient forex reserves of USD 400 Bn, and inflation is benign. Hence, while some countries have raised interest rates to defend their currency, the RBI maintained its policy rate last Friday citing low inflation expectations. However, this spooked the currency markets. Reiterating our view shared last month, we believe the Rupee will continue to have a depreciating bias and investors should recalibrate their portfolios accordingly. (Source: Bloomberg, ABSLAMC Research)
On the domestic front, we saw disruption in the market due to IL&FS, a large financial institution, defaulting on some of its debt obligations. This led to a repricing of risk, especially for NBFCs. Widening of credit spreads on top of the rise in benchmark 10-year yields will impact their margins and tightening liquidity will lead to lower growth over the next few quarters. Both the RBI and the government have indicated that adequate liquidity will be provided to NBFCs even as the RBI has indicated that their current business model, wherein they fund long-term assets with short-term liabilities, is not sustainable. We think there would be near term pain in earnings for NBFCs and wholesale-oriented banks. In turn, lower credit growth will impact the consumer discretionary sector ahead of the busy festive season. (Source: Mint, ABSLAMC Research)
- Amidst macro headwinds, all EMs have seen a sell-off. While the Nifty has corrected 12% from its peak, the midcap index has corrected 25% while the smallcap index has corrected almost 40%. We expect markets to have a soft patch for the next six months till the elections. While the market will bottom out, there is a risk that it may overshoot on the downside. (Source: Bloomberg, ABSLAMC Research)
- Though corporate earnings may be cut due to the previously mentioned developments, overall earnings growth remains supportive. In addition, valuations are now at their long-term average providing a cushion to overall markets. We would recommend that investors continue to build equity exposure for the long term. They will be better off doing SIPs/STPs for the next 6 months rather than lump sum investments. (Source: ABSLAMC Research)
- It would also be prudent for investors to allocate 20% of their corpus to midcap and smallcap funds. Valuations in that space have become reasonable and we remain constructive on overall economic growth. (Source: ABSLAMC Research)
- Sector Outlook
In terms of sectoral outlook, sectors which will be impacted positively by Rupee depreciation include IT, Pharma, Metals and Mining, and Auto ancillaries. We continue to like the Consumer Discretionary space with sectors such as Autos, Small Appliances and White Goods. We also believe that for private sector banks, the increase in market share will be a secular trend over the next decade. (Source: ABSLAMC Research)
Thank You and Happy Investing!
USD: United States Dollar; YTD: Year To Date; FII: Foreign Institutional Investors; GDP: Gross Domestic Product; EPS: Earnings per share; EBITDA: Earnings before Interest, Tax, Depreciation and Amortization; CAD: Current Account Deficit
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