Investment Shastra

May 2019: MoneyWorks4me Outlook

May 2019 MoneyWorks4me Outlook

Review

Nifty Total Return Index (Nifty including dividends) earned 10% Year to date 2019 and ~15% CAGR in last 3 years. FIIs under-own Emerging Market Equity due to poor performance of Emerging Markets in last 5-10 years. We saw increased interest in EM due to i) Cheaper valuation (except India) ii) Fed’s signal to not hikes interest rate leading to Risk ON behaviour iii) Slowing down in Developed market growth after long bull market. India too saw increase in FII interest. Most of the stocks that rallied were either beaten down or index heavyweights like Banks. Some undervalued stocks have also moved up thereby reducing number of investment opportunities. A lot of stocks in Infra space rallied post-election outcome in anticipation of continuation of reforms from incumbent government. Due to narrow rally in select stocks led to all advisors and MFs underperforming headline index, Nifty 50.

Outlook

As on date, average upside of our coverage universe is likely to be ~8% CAGR over next 3 years. Given quality companies are trading at steep price multiples & our coverage mostly has quality companies, expensive valuation is getting reflected in poor upside potential too.

Few advisors are recommending small and mid-cap companies as uncertainty of election is behind us. However, we believe that small and mid-cap are not cheap yet to make risk adjusted returns over an entire cycle. They may rise temporarily however, long term returns won’t be commensurate for the risk one takes investing in small and mid-cap companies. A SIP product may work in such situation but we recommend caution.

Last 10 years belonged non-cyclical companies who exhibited linear growth rates. Also, some stocks that showed non-cyclicality despite being part of cyclical sectors, saw massive outperformance versus their peers. Our expectation is that there will be “reverse to the mean” in stock prices that have run up a lot versus their earnings growth.

Some pockets of the market like consumer staples, consumer discretionary except Auto, chemicals, financials (except corp banks/nbfc) are trading at stretched valuation. We expect mediocre returns from this basket over next 3 years even if earnings growth is good. Starting valuation play an important role in long term returns.

Investor must consider investing in Infra & Infra-related companies through stocks or funds for medium term. Some of the Auto stocks have seen deep cuts and trading at low valuation multiples versus last 5 years. We expect a basket of select NBFCs, corporate banks, utilities, Autos and diversified non-MNC Pharma to earn good returns over next 3 years.

Risks

Many investors were waiting for elections citing it to be one of the risks to equity markets. We had written in previous note that equity returns are not dependent on which government comes to power, but it depends on earnings growth of businesses…We believe that going forward as well, young population, under-penetration in several sectors, under-investment in infrastructure would provide ample opportunities for the companies to grow. This will get reflected in rise in stock prices as well irrespective of which party forms the government.

Election Outcome: Favourable or a non-event?

Narendra Modi led-NDA formed India’s new government by winning around 350 seats in Loksabha, higher than the projections of exit polls and total seats in 2014 elections. The market celebrated comeback of incumbent government with stellar rally a day after exit polls.

Over the last 5 years, NDA government maintained fiscal deficit in guided range by way of divestment in PSUs, increased tax base and unified tax structure across the country. This is expected to continue to keep fiscal deficit in a range.

Numerous sectors were brought out of stress by way of recapitalisation, imposing duties on imports, resolving bankrupt companies through IBC, etc. We are yet to see full implementation of road infrastructure, SEB reforms (UDAY) and tax collection of GST. The benefits may trickle down across economy under new regime. On reforms front, initiatives like LPG connection, financial inclusion, clean India, affordable housing, healthcare and last mile electrification may not have reached every potential beneficiary. We expect new government to expand these policies to larger population.

From financial markets standpoint, need of the hour is easing liquidity to avoid slowdown in consumption/supply. NBFC-led liquidity crisis is making lenders cautious and saving liquidity for a rainy day. Some experts believe lowering interest rate may relieve some stress. We may see this happening in subsequent RBI policies.

Lower oil & flat commodity prices, write off of bad loans and deleveraging of corporate balance sheets should kick start new earning growth cycle. We believe with improving profitability from better capacity utilization, new capacity to come up and generate employment.

Some market participants opine that Modi’s victory would lead to huge market rally and stellar equity returns like it happened in 2014. In our opinion, NDA’s return to the power doesn’t warrant good returns from equity. If Nifty were to correct to fair value today, Nifty’s 5 year CAGR from the start of NDA’s first term was meagre 9%, including dividends. This was due to poor earnings growth over last 5 years and high starting valuation. Starting valuation and earnings growth determine equity returns. At current juncture, Nifty trades at 15% higher than its fair value aka Nifty@MRP. There is limited upside in indices in near/medium term. This is due to some of the stocks are trading at 40-100% premium to their fair value. Rest of the market trades at more or less fair value to slightly overvalued range.

Major risk currently is the slowdown in GDP growth and consumption. Even if long term growth trajectory may be intact, stocks can be very volatile due to high equity valuation. We recommend not to chase stocks that are doing well despite high valuations.

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