A lotus in the mucky pond
HSBC Global Asset Management, India
The year gone by for most investors global or local was very forgettable. While we began the year with the strong returns achieved in 2017 behind us and braced for a more sedate 2018, hardly anyone was prepared for the strong headwinds of the enveloping trade war, substantial rate hikes in the US and local turmoil in the nature of the banking crisis and the issues in the non-banking financial sector.
While the United States remained the most robust economy with regard to strong GDP growth, corporate profits and employment figures, the EU, Japan and the rest of the DMs struggled to achieve growth. Interest rate hikes in the US ensured a strong dollar and higher oil prices also led to a significant deterioration in economies around the world that had trade deficits as well as negative current account balances.
India too had its share of troubles in the form of the twin challenges of a rising crude price and falling Rupee. While in a way these two parameters are linked, the surprise nature of the sharp upmove in crude prices was not expected. There was pressure to rein in the oil price pressure and ease the burden on the common man, however fiscal prudence pointed in continuing the pass-through stance. Interest rates too started showing a steep rise and this was enough to cause some panic in the debt markets.
By the 3rd quarter of the calendar year, as crude prices started to come off the pressure on the currency also started to ease. However the sharp increase in interest rates was causing an altogether unintended impact on the non-banking financial sector. The spark that was ignited by the spreads movement in corporate credit led to a mini crisis. While some commentators were asking whether this could be called India’s “Lehman moment” the sudden freeze in the commercial paper market and the dramatic downgrade of IL&FS led to a panic in the debt markets. Other NBFCs and some private banks came under the cloud of their respective exposures to IL&FS and some NBFC stock prices halved in a matter of weeks. Short term interest rates as well as liquidity became a challenge and led to significant redemptions in the liquid funds managed by various mutual funds.
As we look to see the worst behind us the toll this year has taken on securities markets is hard to ignore. But as we look forward a string of positives emerge. Firstly, corporate India has begun to report robust earnings growth numbers. As of the end of September quarter the NIFTY companies reported a 24% increase in revenues and 16% increase in PAT on a YoY basis. Secondly, with crude prices coming sharply lower, the overall pressure on internal interest rates will now start to ease. The ongoing dialogue between the RBI and the Government has also led to measures that can potentially infuse much needed liquidity in the debt markets. Thirdly the easing of the pressure on the crude prices will lead to a significant reduction on the pressure on the currency itself. This should also ease concerns of domestic stability and the threat of a ratings downgrade. Most ratings agencies have reaffirmed the sovereign rating and have a “Positive” Outlook on India.
We feel that while asset returns have been challenging in India, the divergence on the returns pattern lead to some interesting observations. While mid and small cap indices sharply corrected large cap equity indices such as the Sensex and Nifty reported positive returns for the year to date. Higher interest rates have meant challenging returns in long duration as well as intermediate bond funds locally, the sharply lower yields recently have recovered a lot of the damage. Interest rate hikes in India look set for a long pause in India and if robust corporate earnings growth continues, we can look to a period of strong returns in the Indian markets.
Globally corporate profit growth appears to be peaking, the dollar appearing unlikely to follow this year’s path, emerging markets set to look for a rebound. The differential in returns now is substantial and some equilibrium appears to be called for. We favor emerging markets vis-à-vis DMs for this year and within the set India appears to be a bright spot. Like a lotus in a mucky pond.
However the scenario is not bereft of risks. India will go in for a general election in 2019 and regardless of the outcome the markets will look for assurance that the economic agenda remains paramount. Over the recent years while political tilts have given the economic agenda some quirks, the unequivocal message is clear – No matter what party or political coalition is in power, reforms will remain a priority. In this sense while the inevitable noise that will follow the election will be unavoidable, markets will digest the outcome fairly quickly. Toward the end of the year a more closer look will be needed to assess the impact on the markets in the long term once the new government sets an agenda and identifies people to pursue the same.
The ongoing issues in the banking sector will also cause irritants as will external events from time to time. However the valuation picture is now much more benign as compared to the start of the previous year and the risk – reward situation clearly appears to be in favor of investors. We recommend exposure to equities locally, with select opportunities in the mid and small cap space being prominent. Depending on the individual risk appetite investors can allocate across high quality debt funds in intermediate duration as well as select blended funds that offer carry yield as well as some funds that have the ability to adjust duration calls.
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