Towards the end of March 2019, Indian equities reversed the divergence from global equities and its emerging market peers. The sharp revival in appetite from foreign investors helped, thanks to the US Fed making up its mind in limiting monetary tightening to space out growth concerns. At the same time, domestic investor participation witnessed a marked slow down over the past four months largely attributable to profit booking.
Having said that, we believe, post elections, domestic participation could revive flow into equities as there are no alternative opportunities that seem attractive with much of event led uncertainty now priced in.
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Currently NIFTY50 (Large Caps) trading at 18.3x Fwd. PE against the 3Yrs average of 18.9x and 10 Yrs avg of 17x. Similarly, Midcaps are trading at 15.5x against the 3Yrs average of 22x and 10Yrs avg of 17x. Relatively as well, mid-caps are at a discount to large caps currently, after 2018 saw them getting drubbed severely.
Ironically, it was the large caps that traded at discounts historically – but this time around, mid-caps appear relatively attractive. Having set the backdrop for conducive forward valuations, a look at the underlying market fundamentals paint a bright picture with the economy not doing bad compared to its history. Earnings over the last three years have been anemic, but strong domestic liquidity helped equity markets remain buoyant.
While the headline GDP growth of the economy can be debatable, it is heartening to see that Consumption has passed on the baton of GDP growth to the recently awoken Gross Fixed Capital Formation (GFCF). Capacity utilizations are now a well-published metric that is inching up cheerfully.
This has a bi-fold ripple effect with private capex plans likely to come onstream sooner than later, thus virtuously pushing up the GFCF cycle even further and secondly, firms in the interim capex period hiking up prices as supply keeps pace with demand, thus virtuously boosting corporate earnings.
While, cement dispatches and corporate utilizations are marching higher, cement makers undertook much awaited price hikes in the last week, to improve their realisations. We think, slowdown in auto sales could be short lived and that the ongoing central and state government’s stimuli to rural and urban middle class should help revive the consumption demand. Also, impending rationalisation of GST rates for Autos could help post elections to rev up sales yet again.
Consumer Inflation is close to abysmal 2% levels and expected to average at 3.5-4% in FY20. This has given reasonable scope for monetary easing by RBI as per its recent policy meet. Having said that, policy rate transmission is tricky given the tightness in interbank liquidity, which the central bank has been consciously looking to address through OMOs and USD Buy-Sell Swaps.
This combined with banks and corporate balance sheets’ deleveraging in the past two years could give scope to revive the credit cycle in the quarters to come.
Post Balakot, there is an underlying clamor in the markets pricing in a less likely uncertain outcome from the upcoming General elections. Policy continuity would result in economic stability as markets inherently like “status-quo” if not improvement in policy outlook. But overall, sound macro fundamentals and a seemingly sanguine political outlook keep large cap valuations rich and mid cap valuations much more attractive.
So, the Sensex reaching a new record high of over 39,000 implies rich valuations with little room left for a further re-rating vs last 3Y track record. A possible rotation into more attractively priced mid-caps as well as an assessment of one’s overall equity exposure is the call of the day.
Tactical shifts in these allocations are warranted at current Sensex levels in order to protect returns if any earned from large cap exposures. It is at this stage that wealth managers with an astute sense of paying the right price or valuations for fundamentals step in to play a key part in preserving and growing client portfolios.
The author is Chief Investment Officer, WGC Wealth. The views expressed are the author’s own.