What lies ahead for the equity and debt markets

Earnings will improve from current low base: Manish Gunwani, CIO - Equity Investments, Reliance MF

Lokeshwarri S K

Large-cap stocks have put up a solid show in 2017, though they were trumped by mid- and small-cap stocks. What will drive stocks in 2018? Manish Gunwani, CIO - Equity Investments, Reliance Mutual Fund shares his views.

What is your Nifty/Sensex earnings outlook for FY18 and FY19? Are you revising the estimates for FY18?

We believe FY18 should set the base for a fairly strong earnings growth over the next 2-3 years. There are multiple reasons for our optimism on earnings growth. One, the strong recovery in global growth over last 3-4 quarters should help earnings. There has been a synchronised economic growth in advanced as well as large emerging markets.

Most of the countries have been recording a PMI (Purchasing Managers Index, a lead indicator reflecting the level of activities on the ground) of over 52, which points towards expansion. Various other indicators, such as IIP (Index of Industrial Production), are also showing improving trends.

Two, growth is expected to revive with the diminishing effect of GST/RERA/demonetisation on businesses.

Three, election-related spending in FY19 can act as a stimulus to economy. The coming year is lined with several big State elections, leading to the national elections in 2019. Activities tend to pick up significantly during such periods, resulting in increased demand for several items.

Four, the low base of cyclical sectors should help too. We are coming off a long period of slowdown, which has resulted in many sectors being at their low levels. We believe earnings will improve from the low base.

How comfortable are you with the overall market valuation at this juncture?

While the price to earnings multiple is not cheap for the market, it is balanced out by a strong possibility of high earnings growth in the next 2-3 years. Therefore, we believe that the market is in the middle zone of attractiveness. While the market does offer various attractive opportunities, we find some stocks in consumer and financial sectors very expensive.

Are there any specific themes that could work better in 2018 in the stock market?

We are overweight on banks that lend to large corporates, industrials, particularly engineering companies and pharma. The pace of NPA formation has been steadily decreasing, there has been revival in sectors like steel and power, and the fact that many of these banks were not in favour has made the investment case for these banks stronger in our view.

Engineering companies will be early beneficiaries of the government’s infrastructure push. As far as pharma goes, we believe the sector offers almost similar opportunities as FMCG, albeit at much lower valuations.

Are you increasing the cash holding in your funds, given the high valuations? Should investors also allocate more to fixed income assets?

We are not holding higher than normal cash in funds as we believe the market is in the middle zone of attractiveness. We think there is no need for investors to make any tactical adjustments to their asset allocation at this juncture and they should be closer to their long-term asset allocation levels.

What are your expectations from the Budget?

From taking up significant compliance-related initiatives/reforms, such as demonetisation, GST, ease of doing business, etc., we notice that the government’s focus, of late, has shifted to reviving growth. The announcement of bank recapitalisation, increase in MSPs (minimum support prices) of many farm produce, sops being extended to some sectors, cut in fuel excise duty, etc., are a few one could mention.

We expect the Budget to be a continuation of this intent. It is likely to focus on areas like infrastructure and rural spending. The tilt is likely to be towards reviving growth.

‘Superior growth prospects will drive mid- and small-caps’

PARVATHA VARDHINI C

Vinit Sambre, Senior Vice President and Fund Manager, DSP BlackRock Investment Managers , says that the visibility of growth, post-2018, is what will drive markets next year. However, he expects the outperformance of mid- and small-cap stocks to continue.

What is your outlook for the markets in 2018 ?

In the last three years, the markets have had a dream run on the back of strong macros and focus on reforms by the government. However, the corporate sector has failed to capture that in its earnings growth due to the temporary deceleration caused by demonetisation and implementation\of GST. This has created a low base which is a good starting point for growth to pick up in 2018.

Also, PSU banks’ recapitalisation and strong government capex spends, could drive the earnings momentum further.

On the markets, we believe that a large part of this growth expectation has been fairly wellcaptured in valuations today. Hence we do not expect the market to further re­rate on the back of growth coming back in 2018.

Markets are now focusing on visibility of growth post 2018 and as that keeps improving, it could add to market returns. Without talking of specific levels, we believe the long term earnings outlook (3­5 years) remains quite conducive for equity investors.

Small-caps have seen a stupendous rally in 2017. Are these stocks overheated or are there more opportunities left in this space?

Due to the massive run­up in small and mid­cap stocks, we believe that there are many names which have gone ahead of their historical valuation range. While some of it could be justied due to the expectation of a pick­up in earnings momentum in the future, earnings are yet to pick up in a meaningful way, to the extent that some excesses seem to have been created.

Having said that, the moment we stretch our earnings outlook beyond two years, we are able to identify good  opportunities. New issuances in the form of IPOs or QIPs are also helping us find more opportunities. 

Will mid- and small-cap stocks continue to outperform largecaps in terms of earnings growth?

We do expect corporate earnings to gradually pick up, going forward.

While we cannot speak about future returns, we continue to have condence in our small and mid­cap portfolio of companies. We see them growing much larger in size and scale over the next 3­5 years and hence possess potential to outperform\ their large­cap counterparts.

Simply put, the impetus for mid­ and small­caps is about superior growth prospects in an expanding economy. Going forward, as economic growth improves, we expect the out­performance of mid­ andsmall­cap stocks to continue.

Which sectors are expected to do well in 2018 and why?

We consider that our strength lies in identifying superior companies across different sectors.

However, talking of specific themes, we feel the implementation of GST will be quite transformational for the country and have far­reaching implication for many businesses.

Due to this reform, we expect consumer­oriented companies operating in the organised sector to do well in the next 3­5 years . Secondly, given the decimation which the pharmaceuticals companies have seen, we believe value has started emerging here.

What is your advice to investors looking at small-mid- and micro-cap funds?

Though the small­ and mid­cap space is quite attractive from the perspective of return potential there are also risks associated with investing in inferior businesses. Hence the skill set of understanding businesses  becomes very important.

We carry out a thorough due diligence of the companies we buy in the portfolio. Secondly, we have a strong belief that the small­ and mid­cap category could deliver superior return over the medium to long term.

Hence, our funds in the small­,mid­ and micro­cap categories are suitable for those who are looking to participate in this growth story. Our experience also suggests that a good­quality portfolio tends to outperform even during bad phase.

‘Markets globally are at somewhat elevated levels’

ANAND KALYANARAMAN

Parag Parikh Long Term Value Fund is among the few funds in India with significant exposure to foreign stocks. Rajeev Thakkar, Chief Investment Officer and Director, PPFAS Mutual Fund, shares his outlook on foreign markets and stocks.

With the US markets on a roll in 2017, are valuations in expensive territory? What is your outlook for these markets and the foreign stocks in your portfolio in 2018?

The increase in stock prices in many cases (say, Alphabet, Facebook, etc) has been backed by earnings increases. In companies where earnings growth is not seen (for example, IBM) the stock price has not gone up. Further, part of the price rally can be explained by tax reforms and reduction of the corporate tax rates in the US.

Having said that, the markets globally are at somewhat elevated levels and the return expectations for the future from equities have to be toned down to that extent.

Valuations in a few companies, iconic from the customer point of view but where earnings are not clear to most investors, seem to be on the higher side. Examples include companies such as Amazon, Tesla, Uber and Netflix. At the same time, companies like Alphabet, Facebook and Apple have clear earnings and cash flows and investors can value them conventionally.

What are the key risks you foresee in 2018?

So far, we have restricted ourselves to investing in global multinational companies. These mainly have a listing in the US or in Western European markets. Investing in these companies results in reducing country-specific risk in the portfolio.

In the last few years after the global financial crisis we have seen ample liquidity and very low interest rates the world over. This pumping in of liquidity seems to be coming to an end . It remains to be seen as to how the world copes with this normalisation.

Apart from this, there are always unforeseen global geo-political events. The markets do not seem to be prepared for any bad news coming in. This over-optimism could itself be a risk in the market.

How do valuations in the Indian markets compare vis-a-vis key foreign markets? Do you think it is a good time now to be diversifying and adding exposure to foreign stocks?

Valuations globally are a bit on the higher side. We are investing in individual stocks on a case-by-case basis and not looking too much at the overall market levels.

Our thought on global diversification is that it is a must for each investor and it is not dependent on market conditions or on timing. Investing overseas increases the opportunity set for investors to invest in companies and sectors that are not otherwise available in their home country.

Our mandate allows us to invest in overseas stocks up to a maximum limit of 35 per cent. However, we typically don’t go very close to the limit, as it would result in having to rebalance every time the overseas markets went up more than the Indian markets. We typically limit ourselves to 30 per cent or so.

‘Go for short term, income opportunity funds’

RADHIKA MERWIN

Adverse base effect and firm commodity and oil prices will continue to drive inflation, leaving the RBI with no headroom to cut rates says Amandeep Chopra, Head of Fixed Income, UTI MF

With the recent uptick in CPI inflation, in particular the sharp spike in November, is there any headroom for a rate cut by the RBI in 2018 at all?

We are not expecting any rate cut by the RBI in 2018, the key reason being the trajectory of CPI inflation in recent months. After bottoming out in June, inflation has been trending up. If we extrapolate these numbers, inflation should be in the 4.5-5 per cent band in 2018. Adverse base effect and firm commodity and oil prices will continue to drive inflation. This will leave the RBI with no headroom to cut rates. On the contrary, the recent rise in the yield of 10-year government bond yields suggests that market has already started pricing in rate hikes.

Do you think there is a possibility of a rate hike then in 2018?

The probability is very low for a rate hike in 2018. While the market is factoring in a lot of pessimism in its outlook, we expect inflation to peak and then moderate somewhat. If that trajectory plays out, then the RBI is not expected to hike rates in 2018.

Domestic and global liquidity and demand-supply dynamics in the government bond market had a key role to play in 2017. How will these play out in 2018?

The US Fed shrinking its balance sheet should be offset by the expansion by the ECB and the Bank of Japan. Hence at an aggregate level, we expect status quo on global liquidity.

On the domestic front, however, we expect liquidity to move from surplus to neutral in the middle of 2018. That should impact short-term rates to some extent. So the spreads between short-term rates and the policy repo rate that have narrowed significantly in 2017 should widen in 2018.

On the demand-supply scenario, with the implementation of the recapitalisation of bonds, there could be concerns over incremental appetite for bonds from the banking system. That said, if there is a pull-out from the FPIs, then the RBI stepping in to stabilise the rupee can continue to add liquidity to the system.

What will also be watched by the market will be the Budget and the Centre’s fiscal policy.

So what is your outlook on the 10-year G-Sec?

We expect the yield to have an upward bias. The 10-year yield can trade between 6.85 and 7.4 per cent range. The yields on the new 10-year government bonds when they are issued are expected to be 6.85-7.25 per cent. So we are currently somewhere in the middle of this band.

That said, today the markets seem to be factoring in a worst-case scenario, with the yield over 120 basis points above the RBI’s repo rate. So markets are probably hinting at a rate hike by the RBI along with very high rate of inflation and some sort of fiscal slippage from the government. But a lot of these may not play out.

What is your advice to bond investors in 2018?

In 2017, we had mentioned being underweight on duration. Rather, the focus was on capital preservation and lower volatility in returns. This has played out well as ultra-short and short-term debt funds have outperformed, while long-term bond funds have not done so well.

Going into 2018, we expect the same themes to pay off — short term and income opportunity fund.

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