Uptick but Wealth Edge, Dec 2017

A tremendous journey of Indian Equities in the year 2017 draws near to close. Nifty has delivered ~25% CYTD. Entering 2017 on the back of demonetisation and low earnings growth, the stellar performance of Indian equities has taken many by surprise. Indian stocks have become the most expensive among peers, prompting concerns about valuations overshooting fundamentals amid slow economic growth.

2017 marked a year of splendid economic recovery in global markets. The global economy is benefiting from a combination of loose financial conditions, more supportive fiscal policies in some key countries following years of harsh fiscal consolidation, low inflation and strong global trade. Globally, however, Inflation surprised on the downside. A favourable economic backdrop resulted in strong equity performance across the globe. The global economy will continue to benefit from loose financial conditions and supportive fiscal policies next year. The strengthening is expected to be broad-based and extends to both developed and emerging economies. A couple of risks that still persists globally is an eventual unwinding of the balance sheets starting with US Fed and Geo political risks simmering which is expected to pose some challenges going forward. So far acceleration in activity has not triggered higher inflation, but the question is whether the Goldilocks combination of strong growth and low inflation can persist in 2018.

From a domestic stand point, 2017 saw multiple structural reforms being implemented by the government. 2017 also saw downgrades of Indian growth numbers especially post the dismal second-quarter growth. The culprits were supposedly some after-effects of last year’s demonetisation and looming imposition of GST that dented the business confidence and willingness to build inventories. However, there have been multiple structural developments in 2017 like GST, Real Estate Regulation Act (RERA), Bankruptcy law and the latest being the announcement of a plan to fix the last the missing piece i.e. the banking sector through recap of PSU banks. This should mark a significant improvement for public sector banks that may become more willing to boost lending. In addition, authorities announced in early November a series of measures to lower the GST tax incidence on consumers as well as to reduce the compliance burden for firms. All of these structural measures would help to drive a rebound in growth from 2017’s disappointing levels, with stronger growth to then persist in 2019.

As far as equities are concerned, September quarter was largely a mixed bag with some encouraging green shoots visible. Overall, we saw around 12% PAT growth and 7.8% growth in net sales. We have earlier stated the fact that we will start to see a recovery in earnings but, it would not be as robust as the expectations around it. The constant hope of earnings recovery combined with ample liquidity has resulted in valuations crossing over to the expensive zone and the upside seems to be priced in. Nifty fiscal year consensus earnings per share (EPS) estimates have declined from where they were before the September quarter earnings season began. We continue to believe there is still further scope for earnings and valuation downgrades. High valuations by themselves are not an indicator of an impending correction. But definitely an indicator of risk. The current risk-reward ratio is unfavourable for equities for a shorter-term perspective. Few key variable to watch out for a sustainable earnings recovery is how the PSU recap is implemented and the revival in private sector demand.

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