Macro-data is mixed:
The Indian economy is showing clear signs of revival on certain data points. The CSO (Central Statistical Organization) revised the GVA and GDP forecast for FY18 upward to 6.4 percent and 6.6 percent, respectively, from 6.1 percent and 6.5 percent, earlier.
Also, the Reserve Bank of India (RBI) recently revised its GDP forecasts upward from 6.6 percent in FY18 to 7.4 percent in FY19, citing a revival in investment activity and global growth.
Industrial production has been a bit volatile, but the direction indicates a healthy recovery. With this, India remains on track to emerge as the fastest growing major economy in the world.
However, on the flipside, there are some macroeconomic challenges emerging. First is the sharp rise in crude oil prices, with Brent crude recently breaching the $80/barrel mark.
However, any further increase in crude oil prices would pose a challenge on the current account and inflation front. We have already seen current account deficit (CAD) rising and some projections show that CAD for FY19 could be between 2.5-3% of GDP, if oil prices continue their upward trajectory, compared to 0.7 percent of GDP in FY17.
Second, is the risk of upward pressure on inflation if crude rise further. Also, core inflation (ex-food & fuel inflation) has risen to 5.2 percent in March 2018, from 5 percent in the February 2018 and a low of 3.8 percent in June 2017.
However, the micro is improving with a revival expected in corporate earnings. Corporate earnings have been flattish over the past 4-5 fiscal years due to weakness in certain sectors like metals, IT, PSU & corporate banks, and pharma.
Up till now, a bulk of the market returns have come from P/E expansion. However, we are seeing signs of revival in earnings growth, with growth expected to pick up meaningfully to the latter teens in FY19, led by metals and consumption sectors.
We expect that going forward, market returns will be led by earnings growth rather than by P/E expansion. We are presently positive on consumption, private financials, IT and metals sectors.
Global factors are creating some uncertainty:
The on-going trade-tariff war can cause disruption to world trade and impact global growth to some extent. This could also have a negative sentiment on global markets and cause market volatility in the interim.
However, the trade impact on India seems to be limited. The US tariffs announced so far are largely focused on China and could have regional spill-overs. However, India’s exposure to new US tariffs (as a percentage of overall exports) is relatively quite low.
On the global monetary policy front, the easy monetary policy is on its way out. US 10 year bond yield has hardened sharply since the start of 2018.
In its March 2018 meeting, the US Fed maintained the median forecast of 3 rate hikes for 2018, compared to some market expectations of 4 hikes. This resulted in bond yields to ease in the month of March.
However, recently in April, the US 10-year bond yield breached the 3 percent mark (highest level since 2014), and the 2-year bond yield (which is more susceptible to rate hikes) touched a 10-year high. This has been putting upward pressure on domestic bond yields in India as well.
Flows have been robust, helped by domestic investors:
Domestic flows into equities have been very robust in recent years contributed by record high inflows into mutual funds.
Domestic investors have been shifting from traditional physical assets (like gold & real estate) to equities due to relatively lower returns from the former, coupled with lower bank deposit rates as well.
The introduction of 10 percent long-term capital gains tax for stocks & equity oriented mutual funds in Union Budget FY19 has raised some questions on the continuity of these flows although recent data indicate that mutual fund flows still continue to be healthy.
The influx of domestic flows have also reduced India’s dependence on foreign portfolio investors (FPI) flows to a large extent, where flows have been a bit volatile lately.
Data also shows that India still remains one of the highest overweight positions in portfolios of global emerging market funds.
What should investors do?
Economic growth and corporate earnings growth picking up bodes well for equities. However, with valuations above the long-term average investors need to temper their return expectations in the short term from equities, compared to the past few years.
The long-term story for equities still remains intact, especially for those investors who are investing in a systematic manner, and they should continue with their investments.
We prefer large-cap equities to small/mid-cap equities, with valuations being at a significant premium in the latter segment presently. Slightly risk-averse investors can also look at asset allocation and hybrid funds.
Now is also an opportune time for investors to review their asset allocation. With equity markets running up over the past few years if your portfolio has got skewed towards equities then it probably makes sense to rebalance the portfolio allocation to the intended levels.
On the flipside, if you are significantly underweight equities, and especially if you are a long-term investor, then cut out the market noise and invest systematically in the asset class to build wealth over time.
Past data has shown that equities have managed to beat most other asset classes over the long term, and effectively beat inflation too.
On the fixed income side, we see some uncertainties like crude oil, inflation, a weaker rupee and global monetary policy tightening.
Therefore, we prefer the shorter to medium term end of the yield curve, and investors may be better off presently in short to medium term duration funds to limit their volatility.Disclaimer:
The author is Chief Investment Officer, Bajaj Allianz Life Insurance. The views and investment tips expressed by investment expert on Moneycontrol are his own and not that of the website or its management. Moneycontrol advises users to check with certified experts before taking any investment decisions.