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Economic Outlook & Equity Strategy, Feb 2018

Executive summary:

  • While the broadest synchronised global growth upsurge since 2010 continues and indicators from business surveys suggest manufacturing activity is likely to remain strong, it is expected that the economic environment shall remain conducive for growth in the medium term. However, the recent sell-off is believed to have been amplified by a jump in the VIX as many players are thought to have adjusted their portfolio in line with the change in volatilities. As VIX Index has begun to trend lower probably indicates selling appears to be over and markets stabilizing. Therefore, the sell-off is expected to be a technical one because the economic fundamentals and growth prospects look just as strong as before the pullback.
  • Q3 FY18 earnings: Aggregate Revenue, EBITDA & PAT growth for NSE200 universe came in at 14% YoY, 17% YoY & 8% YoY respectively. Headline PAT growth reflects a meaningful miss compared to consensus expectation. However, the aggregate earnings for NSE200 have been dragged down by a loss from PSU financials. Ex-PSU financials, PAT growth is 17% YoY, which is a relatively decent outcome and reflects recovery from flat earnings of ~2% YoY in H1 FY18. While base effect due to demonetisation in Q3 FY17 has supported the robust growth, nevertheless, the strong growth in earnings, upgrade to downgrade ratio stabilizing (leading to no cut in earnings forecast) and positive management commentaries do indicate that there has been some improvement in underlying demand in the economy.
  • While earnings growth in the commodities sector was the highest, followed by consumer goods (supported by cost control-led margin expansion and low base in Q3 FY17) and private financials (healthy retail credit growth); PSU Financials, Healthcare & Telecom have registered significant contraction in earnings YoY.
  • We find streets estimates of +25% earnings growth for FY19 earnings a little optimistic, as margins in manufacturing segments may be under pressure given higher input prices coupled with recent increase in market borrowing rates. In our view, mid double digit growth may be more likely.
  • Valuations are showing stretch but may remain at elevated levels – Market valuations measured on a blended basis are above fair value zone. Higher valuations may be susceptible to mean reversion in medium term given that the best of macros may be past us. Composite valuations above +1Std Deviation implies higher probability of lower returns in the medium term, notwithstanding a reasonably stronger earnings growth.
  • Equity Strategy: We recognize that Indian equities are not yet in fair value zone. A global environment that is conducive for risk assets, coupled with some more correction in Indian equities may open up space for tactically adding to equity exposure.