CLSA On Why Indian Markets Will See Single-Digit Growth In 2019
Global risks, general elections, oil prices may all add to the Indian market’s lacklustre outlook. But here’s the main reason.
India’s stock market is likely to give single-digit returns in 2019, according to CLSA. Mahesh Nandurkar, the brokerage house’s India strategist, said last year’s best-performing Asian market is currently facing more downsides than upsides.
While the valuations are lower than where we started 2018 with, it is still the most expensive major emerging market in the world, Nandurkar told BloombergQuint in an interview.
India trades at about 17 times its one-year forward earnings which is 12-13 percent higher than the historical average, said Nandurkar, adding that all the other markets such as China, Brazil, South Korea, Taiwan etc are all trading below and that’s where the valuation disconnect lies.
A couple of months back investors had a tough time deciding whether to invest in Indian stocks trading at rich valuations. But with several global and domestic headwinds—U.S. China trade tensions, rising interest rates in the U.S. and a domestic liquidity crunch brought about by IL&FS defaults—the benchmark indices have corrected from its all-time highs.
Another reason why India trades at a premium is because of its strong domestic inflows, Nandurkar said. "Of late, we have seen that trend has been weakening. That is not a good sign."
Adding to that are the several other uncertainties such as global oil prices, the upcoming general elections in India, rupee's continued volatility and fiscal risks, he pointed out.
Nandurkar has set a “flattish December 2019 Nifty target of 11,000”.
Watch the full interview here:
Here’s the edited transcript:
We have come to the close of 2018 and it has been disappointing year. Your recent report says that your Nifty target is 11,000. Single-digit gains for the markets. What brought you to such moderate targets this time?
We have been cautious on markets for some time. We started previous year at very low expectations. Today the valuations are slightly better than what we started 2018 with, but on the balance there are more risks on the downside than on the upside at the moment. We are looking at single digit return from the market over the next 12 months.
The primary reason for the same is the valuations. India is the only major emerging market globally which is still trading above its historical averages. India trades about close to 17 times one year of earnings which is about 12-13 percent higher than historical averages. Whereas all the other markets, be it China, Brazil, Korea, Taiwan, etc., are all trading below. That’s where the valuation disconnect lies.
One of the primary reasons why India trades at big premium on relative basis is strong flows on domestic side and of late we have seen that trend has been weakening which is not a good sign.
We have seen petering of domestic flows that saw earlier in the year. Mutual fund figures have been coming off from their highs. 2018 peak was about $3 billion which is now $1.7 billion. Is that going to be a worry through the year? Do you see reversal in this and some amount of interest coming back in by the time we approach mid of the year?
A $1.5-1.7 billion number a month is still very good. If that number sustains then I don’t think market will have a downside because that’s a robust number. My worry is if that number starts to come down more from that level. If you look at last one month, and there was one more month in the last three-four months, where net inflows were just about a billion dollars. Going forward as we head into times of elections, political uncertainties can drive the flows to a lower level. The big increase of domestic flows on a more sustainable basis coincided with last election back in May 2014. If the market begins to sense any uncertainties on that side, then that could be one possible trigger.
On the FII side we are not seeing any big inflows from that side as yet, which is very logical. If you are getting cheaper bargains in other markets like China, etc., then the typical foreign investor will need to justify why he or she if buying more expensive stocks in India.
The Election Impact
Will the elections have a large impact on long term growth outlook? You will see a change in the kind of spend that the government does, more populist measures. The capex cycle bottoming out and turning around can get delayed and pushed to the end of the year which could be a set back for us.
The political developments can bring about changes in investor’s sentiments. I don’t think it makes such a difference for long term economic growth outlook. For the last 30 years, we have seen various kind of developments with different parties, structures, coalition governments, minority governments, government which haven’t lasted for five years and so on. But the GDP growth has pretty much stayed on course with few 1-2 percentage points here and there.
I am not worried about economic growth outlook. But the investor sentiments can have a near term impact on markets, especially as market multiples are at an elevated level.
Market is factoring in a Modi coalition government. If there is anything which changes dramatically within the election results and outcome of the elections, does that have a significant impact on markets? State elections had complete reversal. Even the BJP lost three states in Hindi heartland, the markets took complete U-turn from there.
If market were to sense some political uncertainties, it will have a negative impact. You have to keep in mind the possible changes in government policy itself. Over last 12 months, we have seen government policy become more on populist side and the capex activity had slowed down. The government is responding to the questions being raised by the farmers. If you read through the election manifestos of state of Rajasthan, Chhattisgarh, Telangana of the major parties, you will have a clear bias towards some element of sops given out to farmers, employment related pay outs and so on. Those type of things will happen going forward. It will not just end in the election because any commitment that any party makes will have to be fulfilled going through the reminder of 2019 and so on.
My worry is the capex, or the infrastructure activities will not improve in any significant manner because the government expenditure will be diverted to some of these things.
On private infra side, we have seen some money coming in from international investors and multilateral, bilateral agencies but apart from that we have not seen private sector pick up just as yet. That’s the key source of my worry which gets reflected in earnings revisions, which are happening continuously on the downside.
We haven’t seen full impact of the NBFC slowdown. The second-round impact of NBFC slowdown as of now, although some of the recent auto numbers which we have seen over last 1-2 months have shown some impact, but we have not seen the full impact of that as yet.
The Twin Deficits
What is the outlook for the twin deficits? Now crude oil has come off significantly. We’ve touched a five year high of 2.9 percent in the second quarter of FY19. Keeping in mind, even crude oil comes back to level of $65, we should be comfortable on it and even on fiscal side?
Crude prices coming down is a very big macro relief. Even if crude remains at $60-65, the current account deficit will be down to 2 percent of the GDP, as compared to close to 3 percent which we saw in first half of FY19. On current account deficit side, things are better. Not so much on the fiscal front. The revenue shortfall is large.
We have been highlighting it for last 12 months that the Goods and Services Tax collections are way too short and now that has become a consensus. Our estimates are that the revenue collection would be falling short by Rs 1.5 trillion in FY19 which is 75-80 basis points of GDP.Mahesh Nandulkar, India Strategist, CLSA
Next year, in FY20, we will see some improvement in it as the GST tax compliance measures such as invoice matching, reverse charge, etc. gets implemented. But the level of shortfall is large. My sense is that we will be taking fiscal issues into FY20.
On twin deficit, one is under control because of the oil prices going down but the second one unfortunately not. If we look at things like sops to farmers, etc, it looks unlikely that fiscal issue will ease in anytime soon.
Global Cues
Will global cues supersede domestic cues in 2019?
Global cues have a large impact. Foreign investors are the largest set of investors. If you compare the value of investments of foreign investor versus domestic mutual fund investor, it is 1:3. So, what happens globally has a bigger impact. In the U.S. - market and economy in last couple of months - things have changed a lot. Couple of months back there was expectation of another two-three more rate hikes by the U.S. Fed in 2019. After seeing the economic data of late and the way the yield curve in U.S. has behaved, suddenly the expectations have changed.
While one might argue the fact that the U.S. Fed might not be hiking rates as aggressively as we thought initially which could be weaker for U.S. dollar and therefore positive for emerging market currencies such as Indian rupee, etc. At the same time, the fact that the change in rate expectations in U.S. is essentially stemming from the possible slowdown in U.S. economy. The possibility of a recession hitting the U.S. in 2019 or 2020 are now rising. That is not an ideal situation for risk assets, equities and EMs to perform in.
My sense of the global environment is not too favorable at this point in time which would support the equity valuations in EMs like India, whether U.S. Fed hikes the rates, or they don’t.
Either way, the global cues seem to be not supportive for Indian markets.Mahesh Nandulkar, India Strategist, CLSA
If they manage to stabilize the global markets, then that is a positive indicator for us as a market. Our correction has started before the correction of U.S. equity market, but the quantum of correction which they are seeing now is way higher than us. Unless and until we see sharp cut in U.S. equity markets, we will probably hold stable for ourselves. Are we correct to think so?
If the U.S. market stabilizes and globally the growth worries abate, then that could be a stable situation. If the growth in U.S. were to abate, it will mean that rate hike worries will come back once again. Rising rates or yields in U.S. dollar terms will not be good news. Overall the Indian markets have corrected as compared to what we were 12 months back.
The earnings growth outlook for Indian equities is looking better as we are coming towards the end of the non-performing-loans cycle. Those things are favorable. It is difficult to argue for 10 percent plus for next 12 months. In that context from risk reward perspective, the credit market has better risk reward that equities market at this point of time in my view.
Rupee Outlook
We are back to levels we were in August 2018, from where the depreciation in currency started with the rise in crude oil prices. We are back to levels at 69.8 per dollar. Does this volatility continue alongside the equity markets?
Yes, in my view. We have seen oil prices coming down and that has been a big driver for the currency to strengthen. We have also seen some amount of liquidity being infused in local markets by the RBI and bond yields have come down. That’s the other reason for currency to be strengthening. I see both the factors have played out. Especially, if you see commentary from OPEC members, they are talking about production cuts. While the market has ignored those cues at this point in time, if we were to see production cuts being implemented, then as things go forward the oil prices will be stable to slightly moving on the upside. That is the first point to keep in mind.
The second is, while the current account deficit will be much more moderate than what we have seen first half, so say around to 2 percent. If oil moves up, it will go to 2.2-2.3 percent of GDP which is manageable. The other factor, which will continue to be an issue, is the capital account. We have seen FDIs are stable though there may be there is slight decline in it. The equity portfolio on equity and debt side have been negative last year. Going into next 6-12 months, I don’t see a reason whether there will be large portfolio inflow as such, especially keeping in mind the political uncertainty.
My sense is that the risk to the currency is more on downside than the upside. I will be looking at INR going to 71 or 72 over the next six months or so.
Corporate Earnings
What have you factored in terms of the full year when it comes to earnings? We have been seeing double digit growth, but to what extent?
Double digit growth for FY19, we will end the year with 8-9 percent mark for Nifty for current financial year. We have seen some disappointment coming from the auto numbers over last couple of months. We have seen some downgrades at back of it. But FY20 will be a much better year from the bottom up perspective, the consensus perspective is more than 20 percent which is coming on back of the expectations that the corporate banks have really seen the worst. The NPL cycle has peaked out. The provisioning cycle will probably peak out in this year. The next year, the credit cost, the provisioning cost will be much lower, and it could be one of the big drivers for corporate earnings growth to be better, and it is valid expectation in my view.
The risk is there in non-banking side where the margin expectations are at elevated level. As compared to street expectation of 23-24 percent growth in FY20, maybe we will end up with 15-16 percent kind of mark, which is good. Over last 5 years or so, the corporates earnings growth for Nifty stocks have been 7-8 percent. 15-16 percent is a very big improvement and achievable. It is the positive side of looking at things.
In SMEs, housing constructions, auto ancillaries - the pockets which needed funding from NBFCs which are bearing the brunt - has the full impact of it been seen or are we going to see it throughout FY19?
I don’t think we have seen the full impact. The primary impact of the crisis, NBFC themselves are seeing from lasts few months. The auto numbers are going to be weaker which is beginning to capture. Autos is one of the few sectors where we get monthly data. There are many other sectors like the consumer or other segments of the economy where we do not get high quality, high frequency data. Those kind of numbers and if any slowdown is happening there, which I think it is, will be known in December quarter season and possibly in March quarter season. I don’t think market has fully captured the second-round impact slowdown. The other sectors which will see impact will be the SME side, there will be impact on construction activity in housing side as well. The housing market has been weak since the 5-6 years. Over last couple of years there have been several fall stars. We were beginning to see some improvement in housing data and then we had the demonetization, GST implementation, RERA implementation and now NBFCs. So, there have been various hurdles that the property market recovery has seen.
Our basic bullish view on housing market stays because the basic fundamental of housing affordability, which are at best level in last 15-20 years, that still stays. NBFC slowdown has hit that recovery for sure. Now we are building in the housing market recovery to get pushed to second half or towards calendar year 2019. But that is not out of the picture as yet.
Next few quarters will bear the brunt of the second round impact (of the NBFC crisis), but the housing market will eventually pick up towards the end of calendar 2019.
Where is the leg up for growth anticipated to come from?
Some sectors where we will have a positive outlook is the banking space in private banking side. Retail or private banks, both segments looks well. It is poised towards regaining market share back from NBFCs. On state owned banks, we have continued to get market share. The banking sector as whole is gaining share back from NBFC.
The other big trend to keep in mind is that the NPL cycle has peaked out. It is good news for corporate banks too and to expect big earnings recovery to happen on corporate banking side going in FY20-21. That is one space which looks very attractive.
We continue to stay overweight on IT services. We are of the view that the currency has downside risks. From bottom up perspective, we still expect 8-10 percent kind of dollar denominated growth for IT services sector. There are relative picks which one can make in those names.
We also like the rural consumption sector. We expect that the government’s focus on policy perspective will remain in that space, not just before but after the elections too. Any government or party needs to fulfill the poll promises. That should help the tractors, consumer stocks which are more focused on the rural consumption side. That is another segment which we are optimistic on.
We also like state owned names from power utility side, oil side where we see valuation attractive. Those are some of the names that we like in overall market.
Budget Expectations
Anything to come about in the budget which will stir the markets.
In general, the importance of budget over the period of time has reduced which is a welcome move. As the economy becomes much more mature, we don’t have to tinker around tax rates every year and it is a good sign and that trend will continue going forward.
For this year’s budget, being a pre-election budget and any new government need to re-look at some of these numbers and so will the market. Feb. 1 budget is unlikely to be a very big event. You will get indications on revenue predictions and revenue shortfall for this year. But it is a well known factor in my view. So, I am not staying up the whole night for budget expectations. Don’t think it will be big event from market perspective.