The current economic crisis has set tone for reforms such as corporate tax cut and labour reforms, and has raised street expectations for more reforms
The calendar year 2020 is expected to be a year of cyclical recovery for the economy and also for corporate profits, which may pick up pace with the market up-move, believes Navneet Munot, Chief Investment Officer, SBI Mutual Fund.
“Stocks are forward looking and are pricing in a likely economic recovery, aided by factors such as ample liquidity, local as well as global, agri inflation along with good monsoons, and lagged impact of lower interest rates,” Munot said.
The factors behind the current dip in corporate profitability are negative operating leverage, high interest burden and high tax burden, most of which are expected to reverse and provide a cyclical uptick to profits going forward, Munot said.
He also said that the current economic crisis has set tone for reforms such as corporate tax cut and labour reforms, and has raised street expectations for more reforms.
The year gone by was a year of contrasts in many ways. While the economy slowed down sharply, equity markets did well as the Nifty and the Sensex grew 12 percent and 14.4 percent, respectively.
Yet within equities, broader markets did not do well with the Nifty Midcap 100 and the Nifty Smallcap 100 indices losing 4.3 percent and 9.5 percent, respectively.
According to Munot, a cyclical recovery will help reversion in profitability metrics such as corporate profits to GDP ratio, Return on Equity (RoE), Profit to Sales, all of which have been declining for over a decade and are at multi-year lows currently. At the same time, it is unlikely that the corporate profitability will go back even remotely close to the highs seen during 2007-08.
Geopolitics, with the recent US-Iran conflict, has come to the fore again and poses further risks to crude oil prices, Munot said.
He feels a theme to watch out for this year could be the return of commodity inflation.
“Inflation revival could help India as corporate performance has shown strong link to global inflation historically- better nominal growth helps through operating leverage as well as reduced debt burden and quicker deleveraging. Better growth is likely have a positive impact on the propensity of corporate to invest,” Munot said.
A rise in food inflation is positive for rural economy and rising inflation expectations helps spur consumer spending.
Munot, however, is of the view that rising inflation makes the Reserve Bank of India’s job difficult. But, given the slack in the economy and contained core inflation, monetary tightening may not be an immediate risk.
In terms of threats to economic recovery, Munot said, “Several structural factors such as a large yet inadequately skilled population, technological disruptions, lack of innovation and environmental concerns to name a few threaten to stall our march upwards.”
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