Over the past two years, market participants have undergone significant pain. The market has been polarized due to a narrow rally limited to a handful of largecap stocks while broader market has not performed.
The key reason has been a sharp slowdown in the economy mainly due to the stress in the Banking/NBFC/Real Estate space and tight liquidity after Demonetization/GST/RERA/NBFC crisis which has especially impacted SMEs and unorganized segment. Increase in risk aversion led to a decline in credit growth which is the lifeblood of an economy.
However, Indian economy has likely bottomed out and should see gradual recovery going forward as the worst is likely behind us.
Resolutions are progressing under IBC, new stress formation has reduced, and bank balance sheets are getting repaired. The worst of the funding crisis for the NBFC sector seems behind us, and with NBFCs improving their funding profile, tail risks on system stability seem unlikely. Commercial Real Estate is relatively fine, and while Residential still has a long way to go, government policy steps can be a positive for the sector. With increased global liquidity and risk-on sentiment, appetite of foreign funds to buy distressed assets has increased which is giving Indian corporates an opportunity to deleverage.
System liquidity is at a surplus of more than 3 tn currently. Overnight yields have fallen below cost of funds for banks. Surplus liquidity and pressure on margins should drive banks to start lending leading to gradual improvement in credit growth. RBI is continuing to maintain an accommodative stance. In addition, rate transmission, which typically takes 6-12 months, should start reducing the cost of borrowing. Post the elections, Government spending is picking up pace which should also add more money in domestic circulation.
The rural economy has been negatively impacted for some time but should see a revival considering the strong monsoons and higher agri prices. Any government stimulus, possibly in the budget, would also help to boost consumption. On the Investments side, Affordable Housing remains a ray of hope. Private capex pickup could be slow as capacity utilization is still low, but the Corporate tax cut should help in the medium-to-long term.
Overall, India’s GDP could grow at 6.0-6.25% in FY21E which would be higher than other major countries. Accommodative financial conditions and easy global liquidity, easing of trade tensions, clarity on Brexit, and cyclical recovery, especially in Emerging Markets (EMs) should support global growth, which is expected to be stable in CY20. EM growth is expected to outpace US and other Developed Markets (DM).
Corporate Earnings growth in India, which was depressed earlier, is likely to pick up in line with improvement in the economy. FY21E Nifty 50 earnings growth is projected to be ~23%. Sectors such as Auto, Telecom, Corporate Banks, and Pharma which had seen a cyclical downturn could see a recovery.
A cyclical recovery should lead to improved investor sentiment. Market is already factoring this in as is evident from headline indices reaching all-time highs. Global risk-on sentiment should also continue, driven by high global liquidity. With continuing FPI inflows, valuation multiples could remain elevated and market is likely to remain ahead of economic recovery. The recent US-Iran conflict can pose a near-term risk to markets as the Indian economy cannot afford an oil price spike currently when the fiscal deficit is under pressure.
Considering current valuations, risk-reward is fairly balanced and returns over a 1-yr timeframe could be in the high single digits. However, market can offer reasonable returns to long-term investors as the economy recovers. Any correction in the market should be bought into while maintaining a balanced asset allocation.
There are still pockets of value in the market. Due to lack of economic growth, Quality has outperformed. Expensive stocks have become more expensive leading to a divergence in the market. Also, mid-and-smallcap earnings had got downgraded. However, as the economy recovers, earnings growth of mid-and-smallcap companies should also pick up as they have a higher linkage to the domestic economy. Risk-on sentiment globally should also lead to continuing FPI flows. Hence, while largecaps should continue to do well, mid-and-smallcaps could catch up and their relative underperformance can reverse. We could see a transition from a narrow rally to broader market participation which provides an opportunity in the event of a convergence.
Select themes of interest are Consumption (esp. low-ticket Consumer Discretionary) as we will continue to see a shift from unorganized to organized, Banking and Financials (esp. Private and Corporate Banks) as the dislocation in the financial system is expected to remain and they will continue to gain market share, Pharma due to attractive valuations, and Cement driven by an expected pickup in Housing and Infrastructure.
Overall, CY20 could likely be a year of a) Consolidation as the economy and earnings catch up with the markets and b) Transition as the broader market starts participating.
Source: ABSLAMC Research
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