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Equity Markets - October 2016

Global growth remains relatively steady although at sluggish levels. Global monetary policy remains highly accommodative – despite some significant changes in the way it is being pursued. Global recession risks appear less acute than early in the year & there are some green shoots in EMs (after improving macro fundamentals, a range-bound USD & rise in commodities prices from February lows). Yet there are fewer signs of a major cyclical rebound in growth. Since Feb 2016, stabilization of conditions in EMs augurs portfolio inflows to continue. While many EM equity indices already reflect the sharp rise due to this benign scenario, but this does not leave enough room for margin of safety.

 

Most of the domestic economic parameters continue to show improving trend. Strong macroeconomic indicators include improvement in GVA growth, negligible current account deficit, highest ever forex reserves, benign inflation trajectory, rebound in food grain production etc. Also, supported by relatively normal monsoons, policy reforms and food stock management, the latest macroeconomic data offers more positives than negatives. Near-term macro data is generally suggestive of a recovery in the economy although more from a consumption perspective. RBI has indicated that they would look at lowering the real interest rate band from ~150-200 bps to ~125bps which could open up room for further rate cuts if inflation moderates (25 bps can’t be ruled out during the current FY).

 

We expect the market to focus on earnings and fundamentals as the scope for further re-rating of multiples is quite limited. Domestic positive events such as 7CPC implementation, good monsoons and decline in interest rates have partly played out but are largely priced in. Consensus earnings for FY2017 has witnessed modest cut in EPS, during the Q1 FY17 results season. The downgrades in corporate earnings seem to have abated for now, although a sustained uptick does not seem imminent.  We expect Nifty-50 Index earnings for FY17 to grow by around 12%, which is not very different from the start of the current fiscal, basis assessment on a top down perspective.

Given the recent underperformance of the export oriented sectors and secular growth opportunity in pharma and healthcare sector we recommend to switch into Pharma sector to the extent of 5% to 10% of the overall equity allocation.

 

The Nifty, NSE MidCap and MSCI India Index have moved up 23%, 33% & 19% respectively from the Feb-16 lows. A large part of the strength, especially over the last few months, has been driven by risk-on mode in the midst of low (and) negative global interest rates. While the macro story is encouraging and markets may trade at elevated levels in the visible future, valuations pose a risk in the near term. We find composite valuations of the market (Nifty-500 Index) expensive. We thus continue to remain cautious on the market from a near term perspective. In addition, global volatility induced by fragile world economic outlook (point well acknowledged in RBI recent policy and as reiterated in our earlier communications) may therefore provide an entry opportunity. Hence, each sharp dip in market should be used as an opportunity to build positions towards equal weight asset allocation. We remain confident that Indian equities is likely to be the most rewarding asset class in the medium to long term.

 

Trump victory - Possible near term risk for EMs Polls do not suggest a decisive victory. As in the case of BREXIT outcome, markets were negatively surprised. Similarly if markets were to be surprised again by a Donald Trump victory, it is likely to be interpreted by markets as a negative development especially for countries dependent on exports to US (e.g. Mexico, China, etc). Low export growth has been one of the key negative forces behind past EM growth. Policy uncertainty could, in such a scenario, increasingly affect FDI and other flows to EM impacting markets. However, this is a risk, not our baseline scenario.