By Navneet Munot, CIO, SBIMF
The magnitude of BJP’s electoral loss in the state of Bihar is likely to embolden the opposition, making it difficult for the Modi Government to carry out critical legislative reforms like GST bill. Having said that, it may also result in a realization for the ruling party that it would have to soften its stand and build broader political consensus to provide positive impetus to policy making. In fact, most of the actions needed to revive the economy are in the executive domain and with one of the most important state election behind us, pace of government action is likely to pick up.
Going by the communiqué of U.S. Federal Reserve last month and a stronger US payrolls data, a policy rate hike in U.S. now looks a near certainty in December. Further, with China joining the monetary expansionary policies of Eurozone and Japan, the chances of serial hikes by U.S. Fed thereafter seems limited, at this juncture. US dollar and treasury yields have been firming up while equity investors seem to be finally getting more enthused by prospects of an economic recovery rather than continuance of zero interest rates. We feel that the event once done will diminish the persistent volatility in the markets. Further, as empirical data suggests, Indian markets have performed well in periods of healthy recovery in the developed economies.
The efforts made by the Governments (both Centre and States), and regulators (RBI) to bring more transparency in systems and procedures, better governance, speedy clearance to investment proposals and rationalisation of tax structure have started producing desired results. Most of these initiatives have been complimented by global agencies when it comes to improvement in ranks for “ease of doing business”, international competitiveness, and even the rating outlook. While this has started being visible in terms of large FDI commitments, we expect even the local business community to start responding soon.
Corporate results for the Q2FY2016 thus far have been a mixed bag. One needs to also witness that the season has been poor globally across emerging markets. Almost a third of the broad market earnings are global in nature and remain impacted by the external environment. Most of the drag on topline is somewhat offset by better gross margins. We expect the current quarter to witness bottoming out of the earnings downgrade cycle. We feel the earnings growth should pick up as corporates start benefiting both in terms of volumes (as demand outlook improves and stalled projects are addressed) and margins (factor cost efficiency in terms of wages, rentals, input costs and borrowing costs). India’s RoE has bottomed out at around 13% in 2014 against 20-year average of 18% with improved outlook on margins and asset turns. The markets remain attractively priced at near 10-yr average valuation at ~16.1xFY16E with an expected EPS growth of 8% for FY16E and 16% for FY17E.
In a growth-starved, yield-hungry world, India clearly stands out as a beacon of hope with its improving macro, evolving policy environment and attractive relative valuation. India is in a sweet spot to attract global capital flows. Concurrent sluggishness in physical assets, recency effect of equity as an asset class and structural move towards financialization of assets make a right brew for increased domestic flows into the equity markets. One is witnessing revival of IPO activity to navigate this renewed appetite. We expect to select a few quality pickings for our portfolios from these offerings.
India is coming off a cyclical bottom. We expect urban consumption to revive on the back of better job growth, low inflation and expected receipts for civil and military personnel on account of wage and pension revisions by the Government. Early indicators like new project sign offs, commercial vehicle and passenger vehicle sales are witnessing improvement.
In short term, market would navigate the political developments post Bihar elections, progress on policy initiatives including GST approval, on-going results season and global developments like US Fed rate/China and resultant capital flows.
Despite the near-term challenges, the long term potential of Indian economy remains intact. The four key themes that drive India today are digitization, globalization, emerging demography and enforced governance. Each of these variables possesses disruptive traits that can challenge the current market structure – creating new businesses, new brands, new categories and new winners. We have reinforced our research efforts to capture these disruptive developments and tactically aligned our portfolio positions to grab emerging cyclical opportunities. Our focus remains on bottom up stock picking from a wide universe of stocks which we believe is the best way to generate alpha on a sustainable basis.
Post the RBI policy review in end-September, bond yields moved lower by about 20 bps in the initial trading days of October but failed to sustain the positive momentum on account of higher net supply during the month. Apart from this, the changing expectations regarding the start of monetary normalization by the US Fed in December had its impact on the rupee and bond yields.
CPI inflation has consistently undershot RBI’s expectation thus far. In y-o-y terms, CPI inflation will pick-up from here owing to waning away of the base effect. Despite an adverse monsoon season, food inflation has been extremely well-behaved thanks to better food supply management by government and muted global food prices. The recent backlash on ruling party due to rise in pulses prices highlights the intolerance for high food prices and contain a strong message for the political class.
We have been highlighting a structural downshift in inflation on the back of global deflationary environment, limited pricing power, better logistics and technology improvements and strong commitment by the government and RBI. But remember, most of the commodities are reaching their FY03 price levels with a much higher cost curve. While the commodity super cycle seems to be over, any further fall in prices from here on looks limited. Our thesis of low inflation stands at a risk in case we witness demand revival from China and/or rise in agro commodities on the back of weather related issues (EL NINO).
The scope for additional policy cuts would largely depend on the medium term inflation- growth outlook. Policy rates may remain stable at least for the remainder of this fiscal, with the focus of RBI now likely to shift towards ensuring better transmission of rates especially in the loans market.
Uncertainty surrounding the evolution of global factors and domestic political developments would keep bond yields volatile with the feedback loop mainly through the currency markets. We remain alert towards any material change in the evolution of macro variables and its impact on market.
Notwithstanding the recent upheavals in the credit space, we believe disintermediation is a strong trend and credit markets are poised for a structural growth. In fact, the recent events reinforce our strong conviction about the importance of robust credit risk management. We stand ready to take advantage of emerging opportunities in the credit space.
Wish you a very Happy Diwali.
Navneet Munot, CFA
CIO – SBI Funds Management Private Limited
November 9, 2015
(Mutual funds’ investments are subject to market risks, read all scheme related documents carefully.)