We believe equity market valuations, now hovering a little above their long-term averages (still expensive), have seen the froth out.
We believe equity market valuations, now hovering a little above their long-term averages (still expensive), have seen the froth out. The top-end of the market is down 9%, and small caps and mid-caps have slid 28% and 18% from their respective peaks in 2018. We also see interest rates more measured—an INR defence risk trading off still-slack inflation—and unlikely to move materially (risks skewed to moderate increases to the upside). And we would argue the INR is vulnerable to oil prices and foreign flows; it has performed well in line with other emerging market (EM) currencies.
So where should India trade—in the run-up to elections and beyond? In our view, India should trade at its longer-term average, or 15–16x. We see this translating into a Nifty range of 9,800–10,500. Anything above, the risks start rising disproportionately; anything below, it’s the opportunities pie that starts widening. It probably won’t seem that way as the election build-up sets in—there will be more optimism with tailwind (and vice-versa), but that’s the way one should play it in our view. But 2019 is a full year; so how does one play it beyond the election?
The real election risk that we see to the market lies in a very unstable, semi-functional government and/or one with no or anti-market priorities. That could hurt—valuation means could be broken. The current government continuing or a reasonably stable government in place should see the economic trajectory reverting to its longer cycles. And valuations moving up a level: which we argue should be closer to 16–17x: a slight premium to averages,but not substantially beyond.
This should translate into a Nifty target of about 11,800 by December 2019: with second half returns a function of where the market ends post-elections. A substantial gain into and out of the election will leave little gain beyond. But weakness prior to/post-elections should effectively offer a lot more.
Banking & finance: Premium on liabilities
Continued uncertainty—such as likely regulatory tightening ahead and anticipated reduction in risk appetite—is a grave challenge for the financial sector. We see a premium on liability-gathering building up; so large credible franchises will be at play.
We expect even greater caution of credit at the system level—so lenders with appetite will benefit, and believe greater credit selectivity will lend itself to steeper pricing power. But with stressed assets beginning to be resolved, some capex on its way, and an effectively narrower play of liability mobilisers and credit providers, we see a sweet spot for a few and the more-dominant banks. We see large private banks in pole position: NBFCs on the defensive, and for the equity market a narrower financial sector set to play with.
Rural: A big government push
India’s rural sector has faced the brunt of relatively unfavourable terms of trade—a mix of weak global prices, relatively restrained government-driven price hikes, weak monsoon until the last year and tepid real estate transactions and prices. This has had its political implications as well and resulted in a fair pushback from the rural populace in recent elections.
Edited extracts from Edelweiss
Securities report – A tale of two halves