"Consumption being a significant portion of the GDP and with favorable demographics of young population and rising per capita incomes, we believe the broader consumption theme is likely to deliver growth from a longer term perspective and is the structural story of India."
DOMESTIC AND GLOBAL EQUITY MARKETS
THOUGHTS ON GLOBAL RISK-OFF SENTIMENT
Global investors, particularly those from developed markets, have historically been observing that whenever recessions have happened the yield curve had inverted about 12 to 18 months prior on most of those occasions. Currently we are observing the inversion of the yield curve in the US and that is obviously raising concerns of a possible recession coming in a year or a two. Will this relationship hold or not is tough to say. What is observed is the fact that the demand is still growing, albeit at a slower rate. The trade tensions in that sense has not resulted in loss of demand entirely but has more to do with the shifting of the sourcing to alternate locations, either to home market or alternate global locations. This is comforting. With regards to India, our economy now is definitely more aligned to the global supply chain than what it was say a decade or two ago. In that sense, there will be some sort of an impact. However, the inherent domestic factors and the growing middle class does provide some structural support and should help offset the impact.
FII’S GET ATTRACTED TOWARDS STRUCTURAL GROWTH STORY OF INDIA
The foreign investors’ move in the country has largely been led by the stability of the various pillars of the economy (Legislative – stable Government with majority; Judicial – functioning legal system; and Executive) and the superior growth opportunity that it offers. We believe the recent sell offs have been on account of global moves in emerging market flows and the lack of much needed fiscal stimulus in budget domestically. However, over the long term, foreign investors’ exposure to the country has been steadily going up. While the structural story for India remains intact, the earnings and cash flow growth has been below par and this can potentially result in some of the historical valuation premium coming down in comparison to emerging markets peers. Our sense is that whenever there is some improvement on the earnings and cash flow front, we could see foreign investors coming back, aside from global factors like flow towards emerging markets.
RETAIL EQUITY SIP SENTIMENT LOOKS POSITIVE
Flows are difficult to predict and behavioral in nature. Having said that over the last
couple of years, the monthly equity SIP numbers have been resilient despite a tough market which is an encouraging sign whereas lump sum investments have slowed down. Domestic retail investors are reposing their faith in the Indian economy and are now investing for a longer period through SIP route than before instilling discipline investment approach.
EXPECTATIONS FROM GOVERNMENT
Some structural reforms have been undertaken over the last few years. It is time that some of these measures come to help. On top of this, what is obviously being much sought after in the media seems to be on fiscal side, (a) counter cyclical sops in select sectors like autos, (b) pick up in real estate activity, (c) some more measures to help the credit availability. On the sentiments side, (a) relief on the recent tax changes for the FPIs and (b) some relaxations on long term capital gains taxation.
While these all could provide some temporary change in the mood, what one needs for more structural changes are measures to improve job creation in the country and private sector capital expenditure. Some recent statements by the government like (a) PM himself talking of industry leaders and wealth creators to be not looked down upon, (b) changes in punitive clauses on CSR compliance and (c) possible easing of criminal clauses under Companies Act unless it affects public etc. are sentimentally positive for the private sector. These are welcome development towards encouraging entrepreneurs and rekindling the animal spirits in the economy. Pick up in pace of government expenditure on infrastructure could help further. These along with faster resolution of corporate stress & disputes and strengthening of executive cadre (to help implement the key reforms and government schemes) could help the financial participants as well as corporates to bring improved economic activity and confidence. The Government could further provide impetus by selectively benefiting low cost housing or investments in renewable energy. All these measures are important to improve the multiplier impact in the economy and help in overall growth which eventually would boost consumption.
ON MONETARY POLICY FRONT
The fourth rate cut by RBI was a welcome move. We believe transmission could improve at a broader level if: (a) small savings rates are also more market rate linked – as currently they are impacting the flow into deposits for banks and thereby deposit rates, (b) somewhere an improvement in the confidence level of the system could restart credit flow. The first one may happen with a lag of quarter or two while the second one is more behavioral in nature.
EARNINGS UPDATE: Q2 2019
The June quarter results have been insipid and have disappointed both on revenue and earnings growth. The economic slowdown has not been broad based and we believe there are still sub-sectors in the economy which are doing well than the headline number. Financials led by select private retail banks and insurance, and consumer related sectors such paints, value retailing, urban staples and select consumer durables did well. We believe that companies who have been better bottom-up executors have done fairly well in these testing times. Automobile sector was badly hit by weak demand, high regulatory costs and liquidity tightness. Telecom sector has been impacted by high competitive intensity. Earnings growth misses were also seen for public sector banks, levered non-banking financial companies and capital goods companies.
It is difficult to say how the next quarter would be like, but rest depends on how the festive season pans out. The improvement in the monsoon coverage and some of the recent steps by the government and the RBI towards improving funding availability could help to some extent. Some counter cyclical measures if brought in by the government could also help in demand recovery, else one will have to wait for the underlying economic activity cycle to start kicking back.
SECTOR IN FOCUS: AUTO
Auto companies have traditionally been large wealth creators in India given that they established global scale business models in two wheelers and small cars. This is now being questioned under the quest for adoption of Electric Vehicles (EVs) and simultaneous investment towards improved emission regulations for internal combustion (IC) engine based models. While one may hazard their own guesses towards the pace of EV adoption and related factors, these uncertainities have a bearing on the demand side of the equation which in turn is being impacted by slower GDP growth related factors as well as the availability of choices for purchase. In this uncertainty, the increased convenience and ease of transacting in the used car market has led to some demand shift to that market. For a revival in demand for new cars, we need a combination of self-help (original equipment manufacturers doing their bit to create excitement), policy support through the much sought after counter cyclical measures (challenge given government focus on fiscal deficit target) as well as improved support for auto ancillaries and dealers from the financial sector. The good part is many OEM companies seem to have healthy balance sheets and they may have to use it to some extent for the above reasons and to capture their fair share of the market when the industry moves into adoption of newer technologies. Structural story of aspiring young population and high growth economy could lead to demand for both Passenger and Commercial vehicles in the longer term.
INVESTMENT THEME IN FOCUS: CONSUMPTION
The current economic slowdown has not been broad based and we believe there are still some sections of the economy doing better than the headline number. High ticket consumption backed by leveraged consumption has, however, seen some moderation and could take some time to recover. At the same time, we have seen value for money business models doing well across a host of sectors like consumer durables, paints, apparel retailers, grocery retailers, urban consumer staples, etc. Even for that matter, some agriculture oriented sectors like pipes did reasonably well.
Consumption investment themes typically are classified as a proxy of consumer staples and discretionary sector. Unlike popular belief, our investment approach towards this focuses on leveraging upon the broader “consumption theme” that India seems to be currently witnessing. We consider businesses which interact directly with their consumers, i.e., following primarily a B2C (business-to-consumer) model. So we don’t restrict ourselves to staples or a discretionary sector and but explore opportunities in cement, retail banks, real estate, telecom, healthcare services, hotels, transportation and other related industries. This approach has worked in favour of us even in current cyclical consumption slowdown phase. Consumption being a significant portion of the GDP, and with favorable demographics of young population and rising per capita incomes, we believe the broader consumption theme is likely to deliver growth from a longer term perspective and is the structural story of India. Hence, this space could throw lot of opportunities for long term investing.
INVESTMENT OUTLOOK CY2019
At the start of the year, we had identified H1 2019 as a period that was likely to be dictated mostly by macro events and earnings delivery in the second half. In that context, this theme has panned out broadly well with macro events continuing to keep markets volatile. Earnings delivery has been restricted to a few sectors and we have mainly focused our portfolios towards these areas through the year and continue to do the same. We are currently overweight private sector banks, insurance, consumer staples, cement, utilities sectors and lot more being bottom up stock picking. Our focus have been to identify sectors/companies which can grow earnings without raising incremental debt or equity or are significantly leveraged.
MARKET LEVELS: WHERE TO NEXT?
It is always tough to predict short term targets of Sensex / Nifty (say by end of December 2019) given there is a lot of flow related movement in the market. We believe that equity is a long term investment product (to reiterate that equity holders have rights over the residual cash flows after paying vendors, government indirect taxes, employees, equipment suppliers, lenders and Government direct taxes); and in that light we have historically seen that markets have - with some lead or lag - tended to deliver returns in line with the earnings. In that sense, over the medium to long term we could see annual returns being slightly above the country’s nominal GDP growth at the index level.
The sector(s) mentioned in this document do not constitute any recommendation of the same and BNP Paribas Mutual Fund may or may not have any future position in these sector(s).
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