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We have seen increased volatility over the past three months due to global macro headwinds as well as domestic developments, and tightened liquidity. There was a sharp 15% correction in the equity market followed by a 6.5% rebound. However, over the past one month, the global macro backdrop has improved significantly and the Q2 earnings season was by-and-large supportive of markets, except for some soft pockets.
Brent crude prices which had seen a sharp rise to USD 86/bbl have declined almost 30% to $61/bbl on the back of higher supply and concerns of a global demand slowdown going forward. We believe Brent crude prices will stabilize in the USD 55-70 per bbl range, which is positive for oil importing emerging economies like India. With a pull-back in oil prices, the Rupee also appreciated to levels of INR 71 per USD and may stabilize at this level if oil prices stabilize. The US is likely to see a soft landing next year as the impact of the current fiscal stimulus fades. Fed rate hikes will be tempered and the USD strength will get abated. The pressure on Emerging Markets (EMs) is expected to ease off. EMs saw a resumption of positive inflows in November. The underperformance of EMs could end, and EMs could recover next year. (Source: ABSLAMC Research, Bloomberg)
2QFY19 GDP came in at 7.1%, below consensus expectations. A continued pickup in capex and manufacturing sector output was offset by lower growth in private consumption and deterioration in net exports due to the high crude oil prices. The RBI maintained its policy rate amidst benign inflation and improving macro backdrop, and the benchmark 10-yr Yield fell to 7.4%. NBFC challenges in terms of liquidity and rollovers which were a big problem a month back have eased off though the market is still tight. However, overall credit growth has remained strong as banks have stepped in to substitute for NBFCs. The Q2FY19 earnings season saw around 3/4ths of the Nifty50 companies coming in-line or above estimates. Nifty companies have shown robust revenue growth of 20%+. However, due to rising crude and commodity prices and currency depreciation, operating margins and PAT have been in the low-to-mid teens. With fall in crude prices and a stable currency, profitability should revive in the coming quarters, especially with the GST implementation behind us. (Source: ABSLAMC Research)
View On The Market
Equity market has seen significant correction and the Nifty50 index has fallen around 10% from its peak, while the midcap and smallcap indices have fallen 20% and 35%, respectively. 2018 has been a year of risk and consolidation in the market. Leverage in any form (F&O positions, company-level, sector-level) has hurt. With earnings catching up, valuation multiples which were fairly high have corrected. The Nifty forward P/E now stands at 18x and the risks seem to be priced in. (Source: ABSLAMC Research)
We believe 2019 will be a ‘Year of Return’, wherein the breadth of the market will improve and one can expect meaningful returns from a bigger basket of companies. A broad-based recovery can be expected around the time of elections in May’19 as major events would have played out. Over the past 3 years, the Nifty has given a return of around 13% annualized. And over the next 3 years, we can expect similar returns.
In the current environment with heightened volatility and uncertainty regarding key events, it would be better to take measured risks and be aligned with quality and a low-beta portfolio rather than a cyclical one. Our strategy is to follow the basics and invest based on bottom-up analysis. On the positive side, we are encouraged by factors such as the large market of 1.35 billion people representing around 15% of the world population, with a per-capita income of ~USD 2,000 and increasing aspiration, GST implementation, RERA, fuel price deregulation, import duty on precious metals, India's trade neutrality with the USA, broad-based earnings growth, valuations now turning attractive post steep correction in broader market, and steady retail SIPs, etc. On the other hands key concerns are volatile crude oil price, strong USD, unpredictable FII flows, fiscal deficit slippage, tight liquidity, uncertainty due to upcoming elections, weak jobs growth, etc. We would like to highlight that a weaker and volatile currency has potential to jump start manufacturing. Xiaomi has announced that they will scale up manufacturing of TVs post success in mobile phones. Weaker INR has also triggered companies like Apple to think of scaling up manufacturing in India as they have realized that the weaker INR hurts Indian sales. Global Investment Guru, Warren Buffett is also testing waters in India with his investment in Paytm.
Time and time again, it has been proven that focus on quality stocks always pays off in the medium to long run, even though one has to endure short-term volatility and use the mispricing of stocks in volatile periods to one's advantage. Companies with cash, strong balance sheet, visionary management, and focus should weather this storm much better and gain market share. They should ideally be great places to invest, especially with profits going up and stocks having corrected. Our endeavour has been to identify and invest in such quality companies.
F&O: Futures & Options; bbl: Barrel; USD: United States Dollar; INR: Indian Rupee; GST: Goods and Services Tax; RERA: Real Estate Regulatory Authority; FII: Foreign Institutional Investors
Mutual Fund investments are subject to market risks, read all scheme related documents carefully.
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