Avoid panicking from short-term pain and volatility
Mahesh Patil
The market started the year 2013 with positive expectations after a spectacular rally in September driven by strong global flows and a new-found urgency in reforms shown by the new finance minister P Chidambaram. One financial year has ended, as we step into the new financial year, a lot of worries that had subsided at the beginning of 2013 have begun to resurface?slowing economic growth, increasing political instability and slackness in further reforms to improve investments and the economic growth prospects.
On the economic front, investors are worried about the waning momentum in economic conditions which have accentuated over the past 4-5 months. The pain in the economy is reflected in certain high frequency data points like industrial production readings, car sales, commercial vehicle sales and the PMI reading. For example, January-March car sales witnessed a decline of 16% year-on-year, accompanied by nosediving commercial vehicle numbers (-31.5% y-o-y). The PMI reading also showed a sign of moderation of 52.0 for March in comparison to 54.20 for February. Although the reading above 50 still signals economic expansion, the pace is undoubtedly decelerating. Moreover, this is led by important components like new orders (52.8 vs 56.3 month-on-month) and new export orders (50.4 vs 53.2 m-o-m), not providing much visibility for revenue growth.
The slow growth is a consequence of the slowdown witnessed over the past few years in investments. The slowdown of investments has started trickling into general economic activities. The other part which has compounded the pain in the short-term is the austerity drive being undertaken by the government from September last year.
While fuel price rationalisation helps the government?s balance sheet, it puts further pressure on inflation and consumption in the interim period. The government expenditure growth rate has come down from 15.8% y-o-y in H1 FY13 to 10.2% in the April-February FY13 period, and the revised estimates for FY13 imply a run rate of 4.5% for H2 FY2013. This spending squeeze by the government as has impacted the overall economy as government consumption constitutes 14% of the GDP.
Over the medium term this is a fruitful exercise as fiscal deficit comes down with a prudent handling of government finances. In fact, for FY14 the projected increase in government expenditure is 16.4% even as the fiscal deficit is expected to decline by 40 basis points to 4.8%. The resumption in normal government activity after the close of FY13 should restore some of the lost economic momentum.
The concerns about the economy over the last few years have led to a change in the market fabric. As the Indian market got clouded by uncertainty (domestic/global), investors flocked to defensive names. This led to a bipolar market where quality and defensive stocks traded at a valuation premium while cyclical traded at trough valuations. This year we expect the valuation divergence to reduce as economy starts to trough, which will provide alpha creation opportunities.
The recent concerns facing the market and probable news flows can keep the market volatile and range-bound for some time. However a range-bound market need not necessarily mean bad for investors. A volatile market provides fund managers with opportunity to pick sectors and stocks which lead to a better alpha creation. It is on that premise we advise retail investors that they should not get carried away by the momentary market volatility, and instead use the opportunity to gradually build a position through systematic investment plans (SIPs) in the equity market.
On the valuation front, the market currently trades at one-year forward price-to-earnings multiple of about 14x (a tad below the long-term average levels), and prices in most of the concerns to a large extent.
The previous financial year witnessed a -15% downgrade in corporate earnings through the year due to a combination poor business environment, margin pressure and higher interest cost. We feel the street estimates have largely factored in a slower economic growth, and a further risk of significant earnings downgrades in FY14 estimates is lower than the past precedence.
In such a scenario, we believe that risk-reward is in favour of long-term equity investors with a high probability of generating good returns. Our advice to investors would be to avoid panicking from the short-term pain and volatility, and reap benefits of the long-term equity market by investing over the next three-five years.
The author is co-chief investment officer, Birla Sun Life AMC