Sensex Poised For 2017 Gains Amid Cautious Optimism

India’s benchmark index, the S&P BSE Sensex, is expected to be on an uptrend next year, braving global, economic, and political uncertainties, but fresh highs are unlikely. Concerns over overseas fund outflows following an interest rate hike by the U.S. Federal Reserve and the government’s sudden currency ban are likely to keep gains in check.

Indian shares had already lost nearly 5 percent of their value in the run-up to the Federal Reserve meeting after Republican candidate Donald Trump's victory in the U.S. presidential elections which sparked a rally in the dollar.

The market sentiment took a further hit after the U.S. central bank hinted at three rate hikes in 2017, from the earlier expectation of two, resulting in an immediate sell-off in emerging market equities.

“It looks like everyone is bracing for an upmove next year and saying that 2017 would be the year when growth would pick-up. But at the same time, the confidence levels don’t seem to be so great,” said Shankar Raman, chief investment officer of third party products at Centrum Wealth Management.

Still, analysts BloombergQuint spoke to expect the Sensex to hit 28,000 by mid-2017 on the back of improvement in macroeconomic fundamentals and easy monetary policy by central banks globally.

Here are some of the key themes that are likely to play out next year:

1. Trump Card

Global markets tumbled in the immediate aftermath of Donald Trump’s surprise victory in the U.S. presidential elections, but staged a healthy recovery thereafter as investors speculated that Trump’s victory may not be as harmful as the market had previously predicted.

Indian shares fell in line with U.S. indices subsequent to Trump’s victory but failed to recover thereafter as the impact of the demonetisation weighed in. On November 9, following Trump’s victory and the demonetisation announcement, the broader NSE index fell about 6 percent intraday though it pared most of its losses to close a percent lower.

Market experts said that Trump’s victory should be seen as a signal that the time had come for fiscal policy in the form of increased government spending to replace central bank activism as a means to stimulate economic growth.

“When President-elect Trump actually takes over the White House, we need to see what his policies are. It can dramatically alter the U.S. growth trajectory if he does get some of this offshore money back in...,” said Jonathan Schiessl, chief investment officer at Ashburton Investments.

India, however, is likely to get impacted if the president elect announces aggressive corporate tax cuts, resulting in big drain of funds, both from bonds as well as equities, analysts added.

"If Trump lives up even to half his promises of cutting corporate tax in the U.S. from 35 percent to 15 percent, allowing money to go back from outside at 10 percent...if he does that, I think a lot of money is going to go back to the U.S.," said Vibhav Kapoor, chief investment officer at IL&FS.

Besides, his stance on H1B visa, which allows U.S. employers to temporarily employ foreign workers, remains a matter of concern for India.

“Trump’s policies may impact other countries more than India but we remain cautious. IT-related fears are mostly discounted in the prices so we may not have further negative outcome on that front,” said Deepak Jasani, head of retail research at HDFC Securities.

2. Overseas Inflows

The December rate hike by the U.S. Federal Reserve comes at a time when other major central banks such as the Bank of Japan and the European Central Bank are still biased towards providing more stimulus.

Emerging markets have benefited from low interest rates in developed markets as investors seeking higher returns have piled money into these markets. A tightening of monetary policy in the U.S. led to higher bond yields and narrowed the yield gap over emerging markets, reversing these flows.

Overseas investors have been net sellers in Indian equities for three consecutive months, paring this year’s inflows to about Rs 28,000 crore, according to data from the Central Depository Services website.

However, analysts said India still remains a preferred investment destination vis-à-vis other emerging markets on account of strong macro-economic fundamentals.

"Investors are looking for bright spots in the emerging market space and I don’t think anyone can dispute local strength here in terms of macros, be it current account deficit, inflation or foreign exchange reserves. So I think people would want to be overweight on India," added Raman of Centrum Wealth Management.

3. Modinomics

Investors are also cautious ahead of the key political events this year including the Union Budget and the outcome of the Uttar Pradesh state elections.

Expectations are running high for a fiscally prudent Union Budget, which could be Modi’s last bold attempt to steer economic growth ahead of 2019 general elections.

"I think the focus is more on long-term growth even at the cost of some short-term challenges. As long as the Budget stays on course, I think it’s a great thing," said Anup Maheshwari, executive vice president and head of equities at DSP BlackRock Investment.

Meanwhile U.P. state elections could further complicate things for the government.

State elections are especially important for Modi's party because state legislators elect members of Rajya sabha or the Upper House of Parliament, where reforms, including the GST Constitutional Amendment Bill, were stuck for a long time because the BJP does not yet have a majority.

"If the BJP’s position gets weakened due to state elections, then the reform thrust gets slowed down," said Jasani of HDFC Securities.

The government has so far failed to approve the Goods and Services Tax laws, dashing hopes of meeting April 1 deadline for the countrywide rollout of the indirect tax regime.

4. Demonetisation

Most analysts said the effects of removing high-denomination currency from circulation will be short-lived and hence, stocks may not fall further in the coming year on the back of this trigger.

The Reserve Bank of India has so far accumulated Rs 12.4 lakh crore worth of old notes while Rs 1.4 lakh crore worth of banned currency is still floating in the market, according to a recent report by Bank of America Merrill Lynch.

Prime Minister Narendra Modi has indicated that the normalisation would be slow even after December 30, signalling sluggish growth in the near term.

The manner in which the government and the central bank tackle the aftermath of the currency ban would be key to watch, as the cash crunch has already severely hurt consumption besides leaving the cash-reliant supply chains of many companies in tatters.

“We are not expecting India to race away any time soon because there is still the uncertainty about the effects of demonetisation,” added Schiessl of Ashburton Investments.

5. Union Budget

The Union Budget 2016-17 is expected to unveil crucial economic reforms including measures to ramp up fiscal spending.

“My take is that after the demonetisation, the government will have to give some sort of stimulus in the form of sops for consumers. I expect an income tax rate cut, then some measures on housing and rural India,” said Raman of Centrum Wealth Management.

“I think the sops are coming, definitely. They also perceive politically that the people have had a hard time (as a result of the cash crunch) and therefore you need to give them some positive vibes so that they can start spending again in a big way. So I would expect some fiscal stimulus of some kind or the other, either through reduced taxes or through increased spending or a combination of both,” Vibhav Kapoor of IL&FS added.