2019: What’s on the cards

5 mutual fund managers share their outlook for the New Year

Mid-cap Equity: Mid-caps can outperform large caps over long term

Vinit Sambre, Head – Equities at DSP Investment Managers

 

 

The unprecedented rally in mid-caps that started in 2014, went on unabated for four long years, delivering a 29 per cent CAGR return (Nifty Midcap 100 Index from January 2014 to December 2017). The lure of earning easy money attracted many investors to this category, leading to excessive valuations towards the end of 2017. Midcaps that generally traded at a discount to large-caps till 2013 started commanding huge premium over large-caps.

During the first quarter of 2018, the Nifty Midcap 100 Index was trading at 40-45 per cent premium (in PE terms) over large-caps (Nifty 50).

The worsening external environment, weakness in global markets, rising oil prices, noise around the election outcome (states and central) led to significant correction in mid-caps, starting August 2018; this was more pronounced in small-caps. With this fall, some sanity has returned to the mid-cap valuations. It still continues to trade at a premium to large-caps; however, the premiums have reduced to about 15 per cent.

Earnings score-card

On earnings performance, sectors such as consumer staples, retail, NBFC, private banks, automobiles and metals recorded good growth over the last few years. However, sectors such as building material, agrochemicals, textiles, pharmaceuticals, telecom and PSUs disappointed.

Overall, as a category, mid-caps have failed to meet the earnings growth expectation over the last few years, making valuations look expensive.

In terms of valuations, despite the recent correction, sectors such as consumer staples, electrical goods, retail and select NBFCs, continue to trade at rich valuations, whereas automobiles, auto-ancillary, cement, select pharmaceuticals, private sector banks, agrochemicals, textiles, engineering products companies and building material companies have seen reasonable correction and provide pockets of opportunity.

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In 2019, there are fears of global slowdown, rising US interest rates and withdrawal of easy money policy. The US-China trade restriction fear looms large and, back in India, we have to deal with the national elections to be held in May 2019.

To add to this, there are demand challenges being felt in automobiles, due to rising cost and regulatory changes; NBFCs due to poor liquidity condition; real estate due to lack of funding and cement due to likely slowdown in government spending. Given this backdrop, the outlook for mid-caps is expected to remain subdued till at least the national elections in May 2019.

On the positive side, India's long-term story looks quite compelling, with big changes like implementation of GST, banking sector reforms and positive demographic trends. These changes are structural in nature and would go a long way in strengthening the economy. The organised sector is likely to benefit immensely going ahead.

We expect consumption-oriented sectors such as automobiles, food, retail, electrical goods and building material to do well due to increasing urbanisation, rising income and growing aspirations.

The banking sector is expected to do well in line with economic growth and as balance-sheets become stronger due to clean-up of bad assets. Pharma has faced challenges over the last three years. Gradual improvement can be expected. While there may be periods of uncertainty and volatility over the next few months, the long-term outlook for mid-caps remains quite positive and they may have the potential to outperform large caps.

However, as a line of caution, the category by nature tends to remain volatile. Hence, it is ideal for investors with higher risk appetite and ability to hold for a long-term horizon of four to five years.

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Fixed Income: Yields to soften

Santosh Kamath, Managing Director, Local Asset Management – Fixed Income, Franklin Templeton Investments, India

 

 

In recent months, the market has been volatile and increasingly concerned about asset-liability mismatch on non-banking financial company (NBFC)/housing finance company (HFC) balance-sheets. The tightening liquidity condition has pushed up borrowing costs for NBFC and HFC lenders. Further, investors are risk-averse after the recent experience, which has dampened the overall market sentiment.

However, there have been positive announcements that have directly/indirectly provided liquidity support to the NBFCs. The RBI incentivised bank lending to NBFCs by increasing the ceiling for lending to a single NBFC by an additional 5 per cent of their capital funds. The central bank has moved decisively to address the liquidity deficit by conducting open market operations (OMO) to the tune of ₹140,000 crore during October-December 2018. It has also announced continued liquidity support till March 2019. Cumulatively, these measures have helped improve investor sentiments.

Many well-managed NBFCs have more assets than liabilities maturing over the next year; therefore, liquidity may not be an issue. Today, a well-managed NBFC, typically, has ~20 per cent capital adequacy ratio, which provides it with a significant buffer. Good NBFCs with a strong balance-sheet and quality management could actually benefit from the current situation by increasing their market shares. NBFCs had proved resilient, post the 2008-09 financial crisis.

During the first half of the year, trade wars, geopolitical tensions, volatile global markets, depreciating rupee and higher crude oil prices led to higher yields. Recent liquidity measures by the RBI, lower inflation, sharp correction in crude oil prices, appreciating rupee and lower borrowings have alleviated the pressure on yields.

Positive triggers

Improving consumption demand and expansion of industrial activity augur well for the economy. Higher capacity utilisation in select sectors, along with better demand conditions indicate an improvement in economic conditions. Lower oil prices, if sustained, may also impact growth favourably.

In line with the above, yields are expected to continue to soften, while exhibiting some volatility. The RBI has mentioned a host of provisions to address the liquidity conditions in the NBFC and HFC sector. The market may draw comfort from these and the spreads, which had widened, may compress gradually. If inflation continues to be benign and global conditions remain conducive, the Monetary Policy Committee (MPC) may consider changing the stance back to neutral in the next meeting. A 25bps rate cut in the second half of calendar 2019 can be expected if crude oil prices remain low and there is a normal monsoon.

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Value Investing: Value opportunity across market caps

Taher Badshah, CIO – Equities, Invesco Mutual Fund

 

How will 2019 shape up? The answer can be arrived at by analysing the past and understanding the present.

Over the last few years, India has been riding on a combination of strong macro conditions, weak earnings cycle and expensive valuations. In fact, by December 2017, mid-cap and small-cap premium versus large-cap went up meaningfully.

As we enter 2019, India continues to have a reasonable macro environment. Inflation is benign and though the twin deficits of fisc and current have gone up, they are in control.

The earnings cycle will bounce back because of mean reversion over the next four-five years, as the previous four-five years have been depressed, and the factors responsible for weak earnings outcomes — such as high non-performing loans and weak capex — are turning around.

Entry valuations

Recent currency depreciation and strong US economy should help export-oriented companies. So India is well placed from an earnings cycle perspective. As far as valuations are concerned, in 2018, there has been a decent correction in mid-caps as well as small-caps, and on an adjusted P/E multiple basis, (adjusted for loss-making companies), mid-caps and small-caps are no longer trading at a premium to large-caps. So, value opportunities are now spread across market caps. Investors should make use of any opportunity — either as a result of election expectation or global factors — to ensure they get the right entry valuations over the next four to five months.

Value-oriented strategies have given reasonable returns over a three to five-year period, as investors benefit not only out of earnings growth but also P/E re-rating. However, investors looking at value strategies should remain patient for at least three years and not give too much importance to one-year performance, as companies take time to turnaround and re-rate.

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Large-cap Equity: Macros to be more supportive

Mahesh Patil, Co-chief Investment Officer Aditya Birla Sun Life MF

 

 

Globally, most asset classes were in the red in 2018 due to macro concerns, especially volatile crude oil prices and strong dollar. Secular growth in the equity market seen in 2017 gave way to volatility in 2018, and India was no exception.

Looking forward, in 2019, the macro backdrop will become much more supportive of markets.

With the US expected to see a soft landing, we will see a dovish Fed and the dollar strength will start abating, which will ease pressure on the rupee.

The macro backdrop for India will be stable with range-bound oil prices, stable rupee, benign inflation, and manageable twin deficits.

India’s economic growth will continue to be steady with marginal improvement in the estimates of FY20. The key driver will be private consumption, which will continue to be on a steady growth path, supported by investments in infrastructure. Government stimulus will boost rural consumption. Credit growth will also remain strong as banks step in for NBFCs.

Going forward, even as there would be near-term pain in earnings for NBFCs and wholesale-oriented banks, broader earnings growth for the market will remain supportive. After a strong 2017, 2018 was a year of consolidation in the market.

With earnings catching up, valuation multiples, which were fairly high, have corrected. An improving growth outlook will drive markets to scale new highs in 2019.

India and other emerging markets now offer favourable risk-reward amid improving growth, supportive macro, healthy balance-sheets, light investor positioning and reasonable valuations.

Consequently, there will be a reversal of the FPI outflows that took place in 2018. In addition, domestic liquidity will sustain in India with SIP flows expected to remain steady.

Elections and market

The general election scheduled next year clouds the economic and market outlook. However, the uncertainty will be over by the first half of 2019.

Clearly, while elections can lead to short-term blips, the market reverts to fundamentals shortly thereafter;market performance is driven mainly by the strength of the economy.

With fall in crude prices, stable currency, and steady economic growth, earnings growth of 15 per cent compounded is expected over the next two years for large-caps. While 2018 had witnessed a risk-off environment, resulting in top five heavy-weight stocks in the large-cap Nifty index contributing to most of the returns, a more broad-based growth is expected in 2019.

The largecap Nifty index valuation at 17-18x one-year forward earnings multiple is ~10 per cent higher than the long-term average. However, given the better earnings visibility, large-cap valuations are reasonable. We should see returns in the low teens next year.

Themes of interest are financials, that is, private banks, corporate banks and select NBFCs, and Consumption, that is, consumer and consumer discretionary.

Sectors which can be avoided are Telecom, oil & gas, and power.

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International Investing: More flows to EMs

S. Krishna Kumar, CIO – Equities, Sundaram Mutual Fund

 

 

The growth cycle in most developed markets is softening. Except the US, the growth in developed economies is likely to inch down to around 2.5 per cent over the next couple of years.

The earnings growth is also expected to drop to around 10 per cent CAGR (compounded annual growth rate) from a high of 25 per cent now. The ongoing correction in developed markets is due to softer growth expectations.

Among emerging markets (EMs), the China-US trade war is an important variable. Chinese growth could be stabilised by targeted fiscal stimulus, supported by monetary policies. The EMs growth cycle is still in an uptick and can continue that way for a few more years, thereby attracting more investment flows. So calendar 2019 may turn out to be a good year for EMs.

Method of evaluation

The rupee has had a 3-4 per cent CAGR depreciation against the dollar over the decades, driven by real interest rate differentials, though the movement is quite lumpy as seen in 2013 and 2018.

The rupee is fairly priced against the dollar now, and no material movement is expected. It is not advisable for Indian investors to look at overseas markets based on just the rupee depreciation angle alone. The overseas asset classes have to be evaluated on their risk return metrics and suitability from an investor’s risk appetite.

Lower crude prices of $55-60 per barrel is a fairly reasonable price for both producer and consumer economies. Emerging economies have the tailwind of demographics in their favour and are attractive.

Global flavour is an asset allocation call. With India being one of the fastest growing countries in the world, supported by strong demographics, retail investors would do far better to invest in Indian assets. However, there are a few areas in technology and innovation where global allocations will help, but the risk for a retail investor could be higher. One can target a 10-20 per cent exposure to international assets.

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