Some food for thought
"Some colors reconcile themselves to one another, others
just clash."
—Edvard Munch (Norwegian Artist, 1863-1944)
Word for the day
Lardy-dardy (adj)
Characterized by excessive elegance.
First thought this morning
Chart of the day
2019 - Outlook
The 2018th year of Christ is ending on an anxious note.
Volatility in financial markets is elevated. Geopolitical rhetoric is also
higher. There are uncertainties regarding US-China trade disputes; UK-EU deal
on Brexit; continuation or otherwise of production cuts by OPEC+; financial
stability of financial institutions in many European countries including
Germany; slowing growth momentum in US and China; and the crypto bubble
bursting, etc.
Inarguably, none of these concerns is new or unprecedented. Most
of these concerns have been present in the past decade, in one form or the other.
The global markets have been stable for most part of the past decade, of course
with intermittent corrections. The returns have been below par in most asset
classes, reflecting the unease of markets with the prevailing trends,
especially prolonged use of non-conventional monetary policies (lower rates and
abundant liquidity), nationalism (attempts at de-globalization), and
protectionism (rising propensity of trade related disputes). The efforts to
supplement the demographic inadequacies of developed nations with technology
substitutes (AI) has also prominently reflected in markets, creating localized
bubbles (FAANG) and areas of depressions in many labor surplus markets.
Standing at the threshold of 2019, I see none of these changing
much in next twelve months. In fact, there is a decent probability that the
anxiety levels actually peak in next 12 months and gradually ease going
forward.
In view of this umbrella view, my outlook for Indian markets is as
follows:
Market Outlook - 2019
In my view, the stock market outlook in India, in the short term
of one year, is a function of the following factors:
(1) Macroeconomic
environment.
(2) Global markets and
flows
(3) Technical positioning.
(4) Corporate earnings and
valuations
(5) Return profile and
prospects for alternative assets like gold, real estate, fixed income tec.
(6) Greed and fear
equilibrium
(7) Perception about the
political establishment
1. Macroeconomic
environment - Positive
My outlook for the likely macroeconomic environment in 2019 is as
follows:
(a) Inflation:
The consumer inflation may average around 4%, though we may see some seasonal
spikes. The core inflation may see marginal rise on the back of higher raw
material prices and wages.
(b) Fiscal Deficit:
We may see relaxation in FRBM targets in election year. Expect rise in
government consumption expenditure rising. The systemic liquidity may return to
normal in 2019.
(c) Rates:
Expect benchmark yields to average above 7.25% for the year. The next move of
RBI would likely be a cut in policy rates in 2H2019. Expect some easing in both
deposit and lending rates.
(d) Current Account:
Expect current account deficit to average around 2.5% for 2019. It may though
worsen to 3.5-4% in first few months.
(e) Savings:
Household saving may grow at slower pace as real wage growth remains poor.
Corporate savings though may be higher due to continued deleveraging and rise
in free cash flows.
(f) Investment:
The government investment expenditure may see some slow down due to higher
allocation to social sector ahead of elections. Private capex may see some
recovery, as capacity utilization improves. Overall, investment growth may see
marginal improvement.
(g) Exchange Rate:
USDINR may average close to INR71/USD.
(h) Growth:
Indian may attain marginally higher GDP Growth rate of 7.5% in 2019, as
benefits of GST, higher MSP, NPA resolution and capex in transportation sector
begin to kick in.
To sum up, the domestic macroeconomic
factors may be supportive of stock market in 2019. Especially, stable rates and
inflation expectation may support growth and some recovery in investment cycle.
2. Global markets
and flows
There is not much divergence in the analysts' and economists'
views about the global macroeconomic outlook for 2019. It is pertinent to note
the outlook of some of the major global institutions:
Morgan Stanley: "We see global growth moderating
towards trend. DMs slow but EMs hold up well, supported by a favourable policy
mix. A Fed pause, weaker USD and softer oil prices reduce external pressures
for EMs – a reversal of 2018. Risks are to the downside – watch US corporate
credit and trade tensions."
Amundi Asset Management: "Even if the economic outlook
is generally satisfactory (growth close to or even higher than potential over
the next two years), the rise in the number of risk factors – especially those
of a political nature – are tending to increase global uncertainty, with this
potentially higher uncertainty affecting investment decisions." Outlook
for 2019 - "Central scenario (70% probability): “multi-speed” slowdown
that risks becoming a synchronised slowdown, due to the multiplication of
risks."
Blackrock: "We see a slowdown in global growth and
corporate earnings in 2019, with the U.S. economy entering a late-cycle phase.
We expect the Federal Reserve’s policy to become more data-dependent as it
nears a neutral stance, making the possibility of a pause in rate hikes a key
source of uncertainty."
CITI Wealth: "Persistent global growth in the face
of heavy bouts of market anxiety on the one hand and monetary policy tightening
on the other are contradictory forces that will ultimately moderate return
prospects for 2019."
Goldman Sachs Portfolio Strategy Research: "Our
economists expect the global economy to slow moderately from 3.8% in 2018 to
3.5% in 2019, led by further softening in China and deceleration in the US.
China has slowed quite sharply in 2018, but with monetary and fiscal policy now
in easing mode, they expect only a modest further deceleration. Yet, with
growth still above potential in most DM economies, they look for continued
labour market tightening, gradually rising core inflation, and in many cases
higher policy rates."
Goldman Sachs Asset Management: "We remain pro-risk heading
into 2019 with a preference for equities, especially EM where the period of
growth moderation is likely behind us. Asset prices and market expectations
have adjusted significantly lower versus a year ago, offering better deal and
creating potential for positive surprises.
NUVEEN Investment Managers: "Slower growth. Rising
rates. More volatility. 2019 looks to be a year that could be challenging for
investors. Yet we believe the markets offer a range of opportunities, and we
are finding a number of investment ideas for our clients."
Robeco Asset Management: In 2018 developed economies have
seen above-trend growth, while emerging markets outpaced developed markets,
though growth has been below expectations. For the most part, this trend looks
set to continue in 2019: we now expect to see sustained, above-trend growth in
developed economies and somewhat stronger growth in emerging countries.
However, next year we expect the markets to have two faces. The bright economic
picture is expected to be overshadowed by concerns that this long bull market
will soon end; think rising interest rates, protectionism, Italy, Brexit.
Investors would be well-advised to prepare for these concerns becoming reality.
State Street: "Despite rising inflation pressures,
our base case does not anticipate excessive wage growth in 2019 or other
imbalances that might tip the global economy into recession in the coming year.
But elevated geopolitical and policy risks might easily unsettle markets,
especially in the second half of the year."
Bank of America Merrill Lynch: "We are bearish
stocks, bearish bonds, bullish commodities, bullish cash and bearish the US
dollar; we expect to turn tactically risk-on in late-spring but start 2019 with
bearish asset allocation of 50% equities, 25% bonds and 25% cash; coming years
nonetheless less asset-friendly than past decade."
Vanguard: "As the global economy enters its tenth
year of expansion following the global financial crisis, concerns are growing
that a recession may be imminent. Although several factors will raise the risk
of recession in 2019, a slowdown in growth—led by the United States and
China—with periodic “growth scares” is the most likely outcome. In short,
economic growth should shift down but not out."
Wells Fargo: The pace of the US economy may not be so
easy to maintain. Outside of US, we anticipate somewhat slower growth in Europe
as the UK prepares for Brexit and Germany's economy enters the latter stages of
its expansion. Uncertainties surrounding tariffs are a concern for China, yet
we expect supportive fiscal and monetary policy to help underpin the country's
economy. On balance we believe that emerging market economic growth should
accelerate, and growth rates in developed economies outside the US should slow
towards their long term trends.
In my view, the global markets are
likely to see higher volatility, as they adjust to normalized monetary policies
and muted returns. The export based economies of Asia and Latin America will
face greater challenges as demand in US and Europe slows down. I shall not be
worried about any hard landing or financial collapse in China. Expect emerging
markets to fare much better than their developed peers.
However, contracting liquidity and
anxiety over Brexit and tariff related disputes, shall keep flows into emerging
markets under check in the 1H2019 at least.
3. Technical
Positioning
I see Indian markets to complete the bottoming process that
started in late 2017 in 1H2019. The denouement may be marked by higher
volatility, sharp rallies and falls. The bottoming may however not necessarily
be followed immediately by a new bull market.
Nifty should likely bottom in 8970-9177 range in 1H2019, and stage
a recovery to a level higher than 2018 average of ~10700.
The 100%+ gain in benchmark indices since August 2013, when the
macro improvement cycle began, is mostly a function of PE re-rating; for
corporate earnings have shown little growth. Moreover, whatever improvement in
earnings is seen, it could be mostly attributed to cost savings (especially
financing cost and raw material advantage). There is little evidence of
improvement in pricing power or significantly higher productivity of capital.
RoEs have in fact declined in past couple of years.
In my view, the PE re-rating cycle is mostly over. Any improvement
in equity returns from this point onward will have to be driven entirely by
earnings growth.
The corporate fundamentals would need to show material improvement
over next 9-12 months to sustain the present valuation levels.
The current implied earnings growth over FY20 is well over 20%. If
we consider the historical perspective, in a slowing global growth environment
and election year, the earnings growth of over 20% has not been sustainable.
Even if we can manage this kind of earnings growth (not my base case) due to
very low base (almost no growth for over 4yrs now), FY20 could be a challenge.
I therefore expect a PE de-rating in
2019. Financials and consumers discretionary may suffer the most.
5. Alternative
return profile
Real estate: Real estate prices have bottomed in
most geographies in the country. In some southern cities there are early signs
of recovery in prices. 2019 may see a recovery in the market led by rising
affordability, higher demand for commercial and retail space, higher cost,
sector consolidation and NPA resolution.
Gold: Gold may witness a strong safe haven demand
during 2019, as uncertainties rise, US yields remain soften, European bonds
struggle and JPY remains unattractive.
Fixed income: It is reasonable to expect fix income
returns to remain in 6-7.5% range, as liquidity eases and inflation remains
low.
Overall, in my view, the return profile
of alternatives is marginally negative for equities. If due to government
incentives, better regulations and other factors, real estate prices recover,
and/or there is a major risk off even globally, this could be a major negative
equity flows.
6. Greed and fear
index
Historically, the most successful, though intuitive, indicator of
greed overtaking the fear in market is outperformance of small cap stocks over
large cap stocks. Implied volatility index is another generally accepted
indicator of fear.
The severe underperformance of broader markets in 2018 and sharp
rise in implied volatility index indicates that fear is the dominant sentiment
at present.
The conditions are therefore ripe for market bottoming.
Expect broader markets to outperform
in 4Q2019, after the market bottoms in 1H2019 and recovery sets in.
7. Perception
about the political establishment
The defeat of BJP in recently concluded assembly elections in some
key states has made the outcome of 2019 general elections quite uncertain.
Though the consensus in market is still expecting return of PM Modi led NDA to
power in 2019, the situation may change as we move closer to election.
The political perception therefore, in
my view, remains a negative factor for the market in 1H2019. However,
regardless of the short term volatility that may be caused due to election
outcome, I do not expect any lasting impact of the elections on market.
Outlook for Indian markets
In view of the positioning of the above seven key factors, my
outlook for the market in 2018 is as follows:
(a) The market may witness
higher volatility during 1H2019, but remain mostly positive in 2H2019.
(b) The returns from Indian
equity may be 8-10%, but broader markets may outperform overall.
(c) Capex, construction,
real estate and real estate ancillaries, large PSU banks, would be the
preferred themes. Global commodities will show a mixed trend with industrial
metals doing better than bulks. Gold may do well.
(d) Exporters (especially
to Europe) may underperform.
(e) Bond yields may touch
a high of 8.2%, and average above 7.25% for the year.
(f) Real estate prices may
stabilize in most geographies and continue to recover in select geographies.
Tomorrow I shall present my asset allocation and investment
strategy for 2019.
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