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Economic Outlook & Equity Strategy, June 2018

Economic Outlook & Equity Strategy

  • Global growth prospects continue to remain conducive (indicators from business surveys suggest manufacturing activity is likely to remain strong) albeit with rising risk from increase in bond yields & appreciating USD which remains key headwind for EM’s
  • Q4 FY18 earnings: Headline earnings growth reflects a meaningful miss mainly due drag from PSU financials. Ex-PSU financials, Coal India and Tata Motors, PAT growth stood at +10% YoY which is a tad below expectations leading to minor downgrades in earnings expectations for FY19.

    Favourable base effect, positive management commentaries and stable operating performance despite input cost pressures do indicate that there has been some improvement in underlying demand.
  • Sectoral highlights (earnings drivers & drag): While earnings growth in the commodities sector was the highest, followed by consumer goods (strong growth in rural and discretionary segment) and private financials (strong retail credit growth); Pharma sector sees some signs of stabilization in US business; Ex-PSU’s Fin., telecom too has registered significant contraction in earnings.
  • Earnings expectation might witness moderation: Consensus estimates of +22% earnings growth for FY19 earnings appears optimistic, given higher input cost pressures and rise in borrowing cost coupled with predominant part of the growth is expected from PSU financials. In our assessment, mid teen growth may be more likely.
  • Institutional flows in Indian markets have remained positive. While DII (esp. MF flows) bought equities worth $7.6 bn, foreign flows remained negative ~$1.4bn on a YTD basis.
  • Upgrade mid and small caps to equal-weight from underweight: Correction in mid and small caps segments of the market coupled with fall in valuation gap between midcaps and large caps to within +1 s.d. of long term average, allocation may now be brought to equal weight stance. Also, sues from technical indicator points towards accumulation. We do not yet expect mid-caps to start outperforming given the range bound market and slightly adverse macros which remains our base case for the near term.
  • Valuations are showing stretch: Market has traded historically at much lower levels. Going forward, valuations may not have much support as macros turn marginally unfavourable coupled with hardening global bond yields and diminishing monetary support by the global central banks.
  • Equity Strategy - maintain low beta stance: Higher oil prices & CAD, relatively higher fiscal deficit and (increased) risk of inflation surprising on the upside may cause marginal de-rating of valuations. At the same time earning growth is currently expected to be in mid-teens in FY19. Both taken together may imply moderate up-move in indices.