This is an extract from a post that appeared in the India Markets Observer 2018, an online publication that brings together experts who discuss these challenges in the fund industry and investing insights and various perspectives.
India had done a remarkable job in repairing its macro economy between CY2014 and H12017. We believe that the best of the macroeconomic improvement is behind us and that from CY2018 to 2020 we may see some deterioration in a few macro variables, though not to the same extent as the taper tantrum period.
Lower commodity prices were the prime reason for India’s improved basic balance of payments but the recent run in crude oil prices poses a threat to the improved current account deficit.
The private sector as well as the government had shied away from spending for a better part of the last three years. But the government is now finally trying to stimulate the economy through various spending measures such as farm loan waivers, policy push on affordable housing, the Bharatmala project, recapitalization of public sector banks, etc.
All of these measures could lead to a higher velocity of money and ultimately could converge into better near-term growth. This may show up in corporate profitability and earnings growth albeit at the cost of deteriorating macro variables.
Key themes for 2018:
- Macro variables may not improve from here, as seen in CY2014 - H12017
- Pollution clampdown will gather pace in China and India aiding select domestic sectors
- Pickup in discretionary consumption led by urbanisation
- Doubling of farm income to aid rural consumption
- Financialisation to gather pace - domestic flows to stay robust
- Earnings may have finally bottomed out
Consumer price inflation is likely to average around 5% in financial year (FY) 2019, up from an estimated 3.7% in FY 2018. Our base case remains for a rate hike in the next 6-9 months, possibly in Q1 FY 19. Nevertheless, we are not expecting an aggressive hiking cycle as the RBI has largely held its ground, and refrained from any significant easing as inflation fell.
We expect 10-year G-Sec bond yields to slowly inch upwards in the next 6-9 months from 7.75-8.0% on account of rising inflation and interest rates.
Earnings may have finally bottomed out but dispersion in earnings will continue, we see headline earnings growth likely to return, given; (a) sequential improvement in earnings (b) the return of inflation; and (c) improved demand from favourable policy and tax changes i.e. consumption push in domestic economy, better global growth and stressed asset resolution.
From the perspective of capital markets and investors, since higher inflation is negative for interest rates, fixed income as an asset class is expected to continue its underperformance and at the same time equities should continue to do well because the early stages of inflation tend to be good for corporate earnings. We are currently in this stage where inflation has a positive impact on corporate earnings. For this reason, we are bullish on equities.
In our view…..
- The macro variables - current account deficit, inflation, fiscal deficit and oil price - which behaved well in the last 3 years are exhibiting mean reversion
- Micros (read earnings) are likely to do well
- In this context we believe the year 2018 could be the year of the ‘U-turns’ for both macro and micros.
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