ANNUAL OUTLOOK 2019: THE YEAR OF SELECTION
The year gone by was more or less in line with our expectations. The micro economy recovered from the initial teething issues related to GST implementation and demonetization led shocks with consumption picking up and acceleration in government spending. However, at the same time, India’s macroeconomic variables declined ‘marginally’ from the unsustainably lofty levels witnessed in 2017. In CY2018, equity markets were volatile as expected. But a sharp correction in mid and small capitalization companies surprised us. Interest rates also moved up along expected lines with the 10 Year Government bond yield reaching 8%, as envisaged1. On the other hand, a slower than expected earnings growth disappointed us. While top line growth was in line with our expectations, growth in profits was disappointing.
We believe that CY2019 will be a tale of two halves.
We expect the first half of CY2019 to witness multiple events which will keep markets more focused on macro variables. However, we believe that in the second half of the year, micro factors will take the centre stage, making stock selection a key for outperformance, both in equity and fixed income portfolios. In our view, the first half of CY2019 will have four key events, among many, to watch out for.
1. The US Federal Reserve monetary policy stance: Focus will mainly be on the pace at which rates are being hiked (two rate hikes indicated as per the latest Fed meeting outcome) and the pace of balance sheet unwind.
2. The US-China led trade war: This could have a bearing on large (as well as related smaller) economies hurting their competiveness, capital allocation, resources and economies of scale.
3. Crude prices: This year we are expecting to see some certainty emerge around crude prices. With OPEC+ production cuts and slower demand growth globally, crude prices might stabilise, which could help market participants and businesses make smarter decisions.
4. The upcoming General Elections in India: This will chart the way forward for India over the next five years, as it will determine the political party and ideology at the helm of the country.
In the midst of uncertainty, the underlying economy will continue to be in a recovery mode. Over the last four years, the economy has witnessed the implementation of several ‘framework’ reforms which have disrupted the economy in the short term. However, we believe these initiatives are likely to fructify in the longer term, helping the economy deliver a stronger and more robust growth.
India’s consumption story has recovered from the demonetisation led shock and we believe it will continue to drive micro level growth for the economy along with continued thrusts from the governments (both state and central) on infrastructure. In the second half of 2019, post the general elections, we believe the focus will be back on fundamentals. The second half is expected to reward superior stock selection wherein key variables like the state of the global economy, stable crude prices and the economic policies of the next government could influence stock prices. Our mandate would be to identify sectors and companies which can sustainably grow earnings at a superior rate over the next few years. Similarly, on the fixed income side, we will have to make important decisions with respect to duration and credit which are likely to have the maximum risk/reward at that point of time.
Equity markets are poised to do fairly well amidst the volatility. Given that it’s going to be an election year, we cannot wish away the volatility; however, we believe that earnings recovery, albeit delayed, will take centre stage post elections. We continue to like consumer facing companies considering their superior growth, positive cash flows, minimal leverage and substantial moat. Banking, especially corporate banks, could provide profitable growth as asset quality improves while retail lending opportunity will provide future growth and fee income opportunities. Infrastructure, unlike the last few years, is also expected to see some traction and thus could provide select opportunities for stock picking. However, we believe exports recovery will continue to remain choppy amidst non-tariff barriers and slower global growth.
On the fixed income front, benign inflation, lower crude prices, a dovish US federal commentary and an expected change in RBI policy stance to neutral, bodes well for growth and the fiscal balance. This, we believe, supported by the liquidity easing measures (OMOs) and government maintaining its fiscal deficit target, could keep the benchmark bond yield in the trading range of 7.10% to 7.40% for the first half of CY2019. However, the direction of crude oil prices and outcome of the election will determine the range for the second half.
To summarise, we expect the first half of CY2019 to be a ‘macro over micro’ environment and the second half to be a ‘micro over macro’ environment.
Indian investors we believe may continue to increase their savings allocations to financial assets, as they move away from real estate and gold owing to benign inflation, high real rates and a relatively stable currency.
We believe that it’s time to tighten the seat belt, to withstand the volatility in the first half of the year when elections are scheduled and enjoy the earnings recovery ride in the second half of 2019 and beyond, through bottom-up selection.
To download the Annual Outlook 2019, please click here.
1 The Year of U Turns: Annual Outlook 2018, Jan 2018 by BNP Paribas Asset Management (India)
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