Meet the Manager . ‘Use volatility to build long-term equity exposure’

In terms of valuation, the Price-to-Earnings ratio (P/E) is currently at a premium to its long-term average, as it was in 2008. However, the P/E seems relatively higher now versus in 2008 as earnings have been muted for the past three years. Nifty earnings growth now is less than half of what it was in 2008, and the Return on Equity (ROE) is also depressed currently, and is just around half of what it was in 2008. However, we believe that we are currently at the bottom of the earnings cycle. We remain constructive on India’s overall economic growth, and expect broader earnings growth in the market to remain supportive, which could improve the ROE and lead to a reduction in the P/E ratio going forward.

If we look at other metrics such as the Price-to-Book ratio for the Nifty, it is just around half of what it was in 2008. Hence, it is more favourable for equities now than it was in 2008. Also, while the large-cap Nifty index valuations are at a slight premium to their long-term average, valuations for the broader market still have the potential to offer reasonable returns for long-term investors.

For Q4FY19, earnings growth for the Nifty index is expected to be around 25 per cent YoY, driven largely by financials — on the back of normalised earnings of corporate banks which are coming off a high base of provisioning in Q4FY18.

Excluding financials, earnings growth for the Nifty is expected to be flattish; it might even show a slight de-growth. Earnings will be impacted by weakness in autos, metals and telecom, given the sharp margin compression, offset partially by healthy growth of cement and utilities, and stable performance by consumer, IT services, OMCs and capital goods.

We have seen weak auto numbers over the past couple of months due to various factors such as higher insurance costs and manufacturers increasing prices of vehicles which meet higher safety standards. Over-estimation of demand has also led to inventory build-up. However, we have seen that demand for high-ticket discretionary items slows down before the elections. We expect the situation to normalise in the next couple of quarters and don’t see this as a structural slowdown. Also, the rural economy has been under some stress, but election spending and DBT (direct benefit transfer) should give a stimulus to rural consumption in the short term.

With the RBI implementing innovative measures such as the rupee-dollar swap, liquidity should no longer be an issue now, and we expect system liquidity to come back to neutral by May-June, post-elections. Credit growth continues to remain strong and will support domestic growth. India has already reached a per-capita income of $2,000. With rising incomes changing the way Indians spend, we believe discretionary consumption will continue to drive India’s growth going forward.’

India’s private sector is responsible for around 45 per cent of the total capex for the country, followed by households at around 30 per cent. However, capacity utilisation has so far been sub-optimal across industries, and the overall capacity utilisation stands at around 76 per cent in Q3F19. Currently, only a few pockets such as cement and light industrials look positive. Heavy industrial recovery of sectors such as steel, fertilisers, non-ferrous and refineries may be pushed to the end of the year.

The key thing to watch for will be the growth trend in the end-market consumption demand, as faster growth in consumption could lead to a pick-up in capacity utilisation rates, eventually leading to capacity expansion announcements by the companies as utilisation reaches 80-85 per cent. Stability post the general elections should also help.

Every election seems important for markets. However, market performance seems to have low correlation with political outcomes over the medium term. While elections can lead to short-term blips, long-term market performance is driven mainly by the strength of the economy. An analysis of the past five general elections has shown that returns post-elections have been mostly positive. Also, FPI flows have generally picked up after the election uncertainty is over.

With global macro conditions having stabilised, and the market factoring in the relatively higher chances of the current government coming back, confidence is coming back to the markets. This led to the rally seen in the past couple of months, especially in mid- and small-cap stocks. While the outlook remains positive, the market seems to have already, by and large, factored that in.

Going forward, we expect the market to have a steady positive bias with moderate returns. We recommend that investors take advantage of any volatility in the markets to build equity exposure for the long term. Investors may consider doing SIPs/STPs for the next six months rather than lump-sum investments. It could also be prudent for the investors to allocate 20 per cent of their corpus to mid- and small-cap funds as valuations in that space still look attractive.

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