Globally, Equities rallied in October on the back of easy liquidity and de-escalation of geopolitical risks, as the US and China signalled a likely 'Phase I' deal on the trade war. Better-than-expected US GDP growth data and monetary easing by the Fed combined with balance sheet expansion also aided sentiment with the S&P500 reaching an all-time high in October. The global macro backdrop remains conducive with range-bound oil prices and stable currency. With a global risk-on rally, Emerging Markets are seeing renewed FPI interest and India saw FPI inflow of USD 2 Bn in Equities in October which is a 6-month high.

Domestic investor sentiment also got a boost. Apart from risk-on sentiment globally, better-than-expected Q2FY20 corporate earnings, albeit off beaten down expectations, and expectations of further measures being announced by the government to boost the economy led to a rally in Indian Equity markets. Market breadth also improved. Midcaps posted their best month in over seven months and the midcap index is now up 10% in the past two months.

The domestic economy continues to face some challenges as credit demand from both households and businesses has slowed, banks continue to be risk averse, and businesses are shrugging off investment incentives in light of the current demand slump. In response, the government is adopting a coordinated fiscal-monetary policy response to arrest the slowdown. Even as tax revenue in H1FY20 has been subdued, government expenditure grew by 14% yoy as the government released liquidity into the system through accelerated spending, quicker PM Kisan disbursements, and faster settlement of GST refunds to Micro, Small and Medium Enterprises (MSMEs). The Finance Minister recently announced setting up of Rs 25,000 Cr real estate fund to reduce stress in the sector which should aid allied sectors like Financials, Construction, and Cement and Building Products. The RBI has cut its policy rate by a cumulative 135 bps in YTD CY19 and is also maintaining a liquidity surplus. Further rate cuts are expected.

Going forward, resolution of some of the ongoing NBFC issues, reviving the credit cycle and ensuring rate transmission, and kick-starting bank lending to MSMEs will be crucial to get the economy back on track. The task force on direct tax has reportedly recommended substantial cuts in income tax slabs for individual taxpayers. If approved, this can give a substantial boost to demand. Any investor-friendly measures regarding LTCG and DDT will also boost investor sentiment. Obviously, an acceleration in the government's privatization program is needed to offset the pressure on the tax collections front. Overall, with the various steps being taken by the government and with further measures being expected, it looks like GDP growth has likely bottomed out in H1FY20, although the improvement will be gradual.

The Q2FY20 earnings season is in progress. Of the 32 Nifty companies that have reported results so far, 75% of the companies, mainly in the Auto, Private & Corporate Banks and NBFCs, , FMCG, Cement, and IT companies came in above or in-line vs. estimates. Adjusted PAT for Nifty companies grew by 8%. Excluding Corporate Banks, PAT increased by ~6.5%. Consumer Staples have reported slower sales growth but beat on net profits. Within Autos, overall profits declined but came ahead of estimates driven by better pricing, lower tax rates, and softer input costs. Within Tech, reported profits was largely in-line with mixed guidance trends. Banks have reported in line so far amid moderation in retail loan growth. Corporate private banks missed amid impact from write-down of Deferred Tax Assets (DTAs). Industrials were mixed. Cement stocks reported in line amid lower input costs.

View on the Market:

Earnings growth has likely bottomed out and we should see an uptick from here as the economy recovers. Nifty FY20 earnings growth of 15% is expected. Sectors such as Corporate Banks, low-ticket consumer durables, consumer staples, Cement, and Pharma should drive earnings growth.

Over the past one year, the Nifty is now up ~13% while the midcap and smallcap indices are still down 3-7%. Currently, risk-reward for equities is fairly balanced. Yield gap ratio for the Nifty is marginally in attractive zone even as the Nifty 1-yr Fwd P/E is at a 20% premium to its long-term average. Midcap and Smallcap indices are trading at a discount to Nifty and are reasonable at current levels even as many individual mid-and-small cap stocks are still available at reasonably attractive valuations.

Some of the positives like support for the Real Estate and allied sectors, accelerated govt spending to release liquidity, lower interest rate, and easy global liquidity will all help to revive India's sluggish growth and keep market sentiment positive from a medium to-long-term perspective. Although returns over the short-term could be modest, valuations have potential to offer reasonable returns to long-term investors. We believe that the current environment is well-suited for bottom-up stock picking. A multicap fund stands out in these conditions as it provides full flexibility to move across market cap and sectors.

Select themes we are participating in are Consumption (i.e. Low-ticket Consumer Discretionary, Staples, Retail), Financials (i.e. Private banks, Corporate Banks, select NBFCs and Insurance), Industrials (Capital Goods, Infrastructure, and Cement), and Pharma.

Source: ABSLAMC Research, Bloomberg

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