Globally in 2018 most asset classes were in the red over economic concerns – especially stemming from volatile crude oil prices, a strong U.S. dollar, and rising bond yields. Geopolitical events, and domestic issues in India, including higher interest rates and upcoming state elections added to investor concerns.
We are optimistic that in 2019 we could see the macro economic backdrop improve and become more supportive of equity markets. Indeed, the U.S. economy may have a soft landing, with the U.S. Federal Reserve Board possibly taking a more dovish stance on interest rates, which could reduce the upward pressure on the U.S. dollar.
The macro fundamentals for India may also improve. Oil prices could be range bound, the Indian rupee may be more stable with benign inflation potentially continuing. As well, the Reserve Bank of India has signalled that it will more accommodative in 2019.
If the economy does improve in 2019, one of the key drivers will likely come from an increase in domestic consumption, supported by government and private investments, particularly in infrastructure.
In fact, increases in domestic consumption may continue on what has been a steadily rising growth path, driven by favourable demographics, rising urbanization and a shift from the unorganized economy to organized.
The economy could also benefit as India’s large middle class, and growing affluent class (top 1%), increase their discretionary spending. Additionally, government stimulus spending in an election year could give a boost to more modest income earners in rural areas.
In the private sector, bank balance sheets are improving. Credit growth may remain strong as banks step in to help Non Banking Financial Corporations which have been hurt by non-peforming loan portfolios. Although the housing sector faced challenges in 2018, reforms such as the Real Estate (Regulation and Development) Act and the Affordable Housing Act may drive up investments in real estate over the next few years.
At the same time, the government is continuing its investment in infrastructure development, particularly in road and railway projects. As capacity utilization increases around these projects, we could start to see private investment in these types of projects pick up.
With regards to earnings, there may be near-term pain for Non Banking Financial Corporations and wholesale-oriented banks, but broader earnings growth for the market should potentially remain supportive. By our estimate, we may see solid earnings growth from a substantial number of companies on the NSE Nifty 50 Index in the first half of 2019.
As we enter the new year, India and other emerging markets now appear to offer favourable risk-reward potential amid improving growth, supportive economic fundamentals, healthy balance sheets, and, what we believe, are reasonable valuations. Consequently, we may see a reversal of the capital outflows from equity markets that took place in 2018. In addition, domestic liquidity may be sustained in India, in part by the Systematic Investment Plan, which allows India citizens to invest on a regular basis in their markets
Markets may improve in 2019
After a strong 2017, 2018 was a year of consolidation in the market. In local currency, the NSE Largecap Nifty 50 Index fell around 8% from its peak, while the midcap and smallcap indices fell nearly 20% and 35% respectively. With earnings catching up, valuation multiples, which were fairly high, have corrected along with the markets.
Currently, valuations on the NSE Largecap Nifty 50 Index are around 18x one-year forward earnings, about 10% higher than the long-term average.
Even so, we believe given better earnings visibility, valuations appear to be reasonable. And if the growth outlook improves, it may drive markets higher in 2019, possibly delivering returns in the low teens.
India’s upcoming general election clouds the economic and market outlook. However, the uncertainty may not last. Indeed, analysis of market performance around past general elections shows that returns in the 6-month period both before and after election day have been mostly positive.
Also, foreign investment in India market has generally picked up after the uncertainty caused by elections dissipates. Clearly, while elections can lead to short-term blips, the market often reverts to fundamentals shortly after, with the market’s performance driven mainly by the strength of the economy.
Our investing themes of interest for 2019 include: financials (private banks, corporate banks and select, non-banking financial corporations and consumption, (consumer and consumer discretionary.)
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