Global equities witnessed one of its worst months in August, 2019 on the back of significant negative headlines on India’s economic slowdown and US-China trade war. After enduring a volatile month, the large cap Nifty50 index ended flat while the midcap and small cap indices declined 1.5-2.0%.
India’s Q1FY20 real GDP growth at 5.0% YoY (a 6-year low) came significantly below consensus expectations of 5.7%. There is now a meaningful downside risk to the RBI’s forecast of 6.9% real GDP growth for FY20. Slowing economic growth and the ongoing crisis in the NBFC space could continue to have negative implications for equity markets unless address in a systematic manner.
Fortunately, the government is responding with the Finance Minister’s announcement of several measures to address growth concerns and improve business sentiment. The surcharge on capital gains for both domestic and foreign investors announced in the Union Budget on 5 July was reversed. Other measures were announced to address interest rate transmission, improve liquidity and credit flow, mitigate the auto sector slowdown, and attract foreign investments in select sectors. Lastly, the government also announced the amalgamation of ten Public Sector Banks into four, leading to larger banks with bigger balance sheets and benefits from merger synergies to revive credit growth in the economy.
RBI also continued its interest rate cut policy by an unconventional 35bps cut, adding up to 110 bps in CYTD19. We expect additional 60-75bp easing in this cycle with another cut at the next review in October. In addition, the government will receive Rs1.76tn (~0.85% of GDP) from the RBI, including the annual dividend and one-time surplus capital transfer, which should help to offset any shortfall in tax revenue and get liquidity flowing back into the economy. We also saw a strong progress of the monsoon and cumulative rainfall is now at its Long Period Average on an aggregate basis as of end August which should revive agriculture growth and the rural economy.
August which should revive agriculture growth and the rural economy. Slowing economy led to 1QFY20 aggregate earnings missed subdued expectations. Aggregate Revenue/EBITDA/Adjusted PAT growth for Nifty is at 7%/2%/3% yoy. Overall, breadth of earnings was balanced, however the full year fy20 earnings estimates for the Nifty have been downgraded by ~5%.
On the global front, an escalation in the US-China trade war has led to increased volatility and a deterioration in the growth outlook. In response, global central banks are continuing the shift towards a more dovish stance which should make it easier for the RBI also to cut rates. With global growth slowing, Brent crude prices have remained around $60 per barrel which is beneficial for India. However, the Chinese Renminbi depreciated below the psychologically sensitive 7.00 threshold (currently at 7.15 vs USD) and the Rupee also depreciated 3-4% to the USA. Emerging Markets saw FPI outflows in August and India was no exception seeing a net outflow of US$2.3bn in equities.
View on the Market:
Currently, the valuation in equity markets are significantly in favor of investors, with the 1-yr forward PE and PB multiples for the large cap Nifty index are close to their long-term average. In addition, for Mid-and-small caps PE valuations are also significantly below their long-term average. Overall, the risk-reward seems to be fairly balanced with Equities with valuations having the potential to offer reasonable returns to long-term investors. Overall, market performance and returns could be modest in the near term due to current economic turmoil. However, as we start seeing some green shoots of recovery in the economy, particularly in the festive season ahead it could lead to improvement in market sentiment. The equity sentiments in India and globally remain very weak, however that could also change quickly on back of policy actions and trade related agreements. For Indian equities, the resolution of the key stressed NBFCs and large corporates could be the key to changing equity market sentiments, going forward and in this respect next few months are crucial.
Investors may continue to build their exposure to equities, especially through SIPs and may allocate 20% of their corpus to mid-and-small cap funds.
Source: ABSLAMC Research, Bloomberg
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