The 2019th year of Christ is ending on an disruptive note.
Socially & politically, more than half the country is witnessing violent
protests and unrest. People appear anxious and divided. The economy is also
witnessing one of the sharpest slowdown in more than a decade. The business and
consumer confidence has collapsed. More than half the population is witnessing
stagflation, with no to negative change in wages and consistent rise in cost of
living. The unemployment is on the rise and manufacturing growth is
contracting. The expectations of higher, faster and sustainable growth through
political stability have been mostly belied. Geopolitical rhetoric is also
higher.
The uncertainty over trade conflict and Brexit seems to have
eased a bit, but these are far from over. The global economic growth momentum
continues to be stuck in slow lane. Despite unprecedented monetary and fiscal
support, the growth trend has failed to accelerate in most of the advanced economies.
The recent growth peak, which was much lower than the pre global financial
crisis (GFC) trend peaks, is widely accepted as the new normal. Accordingly,
the low rate and easy money conditions are also widely accepted as new normal.
The Indian financial markets have faced lot of turbulence in
past couple of years that may not be adequately reflected by the benchmark
indices close to all time high levels. Investors have struggled with below par
returns in both equity and debt portfolios. The losses have been particularly
pronounced in small and midcap equity and below investment grade bonds.
In global markets also, the equity returns have been erratic and
skewed. With almost US$15trn worth of bonds trading at negative yield, the debt
returns may have been decent but highly tentative.
Standing at the threshold of the new decade of 2020s, I see none
of these factors changing materially in next twelve months. Though, there is a
decent probability that the storm gathers more fury in next 12 months before subsiding.
With this umbrella view, my outlook for Indian markets is as
follows:
Market Outlook - 2020
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 etc.
(6) Greed and fear
equilibrium
(7) Perception about the
political establishment
1. Macroeconomic
environment - Negative
My outlook for the likely macroeconomic environment in 2019 is
as follows:
(a) Inflation: The
consumer inflation may average around 4.5%, after the seasonal spike subsides.
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 for FY20 and FY21. Expect rise in government
consumption expenditure. The systemic liquidity may remain surplus for most part of 2020.
(c) Rates: Expect
benchmark yields to average above 6.65% for the year. The next move of RBI
would likely be a cut in policy rates. Expect easing in both deposit and
lending rates also.
(d) Current Account: Expect
current account deficit to average around 2.2% for 2020. It may though worsen
to 3% for few months if oil spikes.
(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 remain low due to higher allocation to
social sector. Private capex is unlikely to see recovery in 1H2020, as capacity
utilization remains poor. Overall, investment growth may see marginal improvement
from a low base.
(g) Exchange Rate:
USDINR may average close to INR72.5/USD and move in 70-76 range.
(h) Growth: Indian
may attain higher real GDP Growth rate of 5.8 to 6.2% in 2020, as benefits of
IBC, Tax rate cut, higher MSP, etc begin to kick in.
To sum up, the domestic macroeconomic factors may not be
supportive of stock market in 2020, despite lower rates.
2. Global markets and
flows
There is significant divergence in the analysts' and economists'
views about the global macroeconomic outlook for 2019.
In my view, the global markets are likely to see higher
volatility, as they continue to adjust to the normalized monetary policies and
muted returns. The export based economies of Asia and Latin America will
continue to face challenges as demand in US and Europe remains slow and Sino-US
trade relations take further steps towards normalization. I shall not be
worried about any hard landing or financial collapse in China, though the
situation in Hong Kong does require a closer watch. Expect emerging markets to
fare better than their developed peers. The rising yield differential and risk
on trade after Brexit and Sino-US deal could lead to significantly higher flows
into EMs.
3. Technical
Positioning
Technically, the benchmark indices are not yet ripe for a major
correction. We may however see the broader markets and benchmark indices
converging from the middle of the year. For the year, Nifty 50 may materially
underperform Nifty 500. The small cap may however continue to underperform.
Nifty may move in a very large range this year. On the downside,
it may trade in 9730-10564 range. The upside though appears limited to
12700-13111 range. The risk reward therefore is clearly negative at present.
The 120%+ gain in benchmark indices since August 2013, 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 FY21 is well over 25%.
If we consider the historical perspective, in a slowing global growth
environment and election year, the earnings growth of over 25% does not appear
attainable. 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), FY21 could be
a challenge. I therefore expect a PE de-rating in 2020.
Consumption is the space that may suffer the worst. IT,
Insurance and large Realty are the sectors that look positive for 2020. Amongst
others, agri input may do well as food inflation drives higher spending power
in the sector.
5. Alternative return
profile
Real estate: Real estate prices may continue to be
under pressure in most geographies, though a few cities may see uptrend. The
uptrend in demand and prices for commercial and retail space may also plateau
in 2020.
Gold: Gold may witness a strong safe haven demand
during 2020, as uncertainties over USD & GBP rise and US yields remain
soft.
Fixed income: It is reasonable to expect fix
income returns to remain in 6-7% range, as liquidity eases and inflation
remains low. The yield gap that favors bonds presently may sustain for most
part of 2020.
Overall, in my view, the return profile of alternatives is
neutral for equities.
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.
The severe underperformance of broader markets in 2019 indicates
that fear is the dominant sentiment at present. There is little to suggest that
the sentiments may change in next 6 months at least.
However, I expect the broader markets to outperform overall in
2020, with most of the outperformance coming in the later part of the year.
7. Perception about the
political establishment
The setback to the BJP in recently concluded Maharashtra
elections, after defeat in key states of MP, Chhattisgarh and Rajasthan last
year, and widespread unrest following the enactment of Citizenship Amendment
Act, amidst persistent economic slowdown has weakened the public opinion about
the political establishment. However, considering it is only the first year of
the 5yr term, in which BJP will continue to enjoy overwhelming majority in Lok
Sabha, the implications of this fall in popularity may not be significant. The
fact that the ruling NDA's position may get somewhat weakened in the upper
house over next two years, there are chances of BJP softening its stand on
controversial issues. For 2020, however, expect the political conditions to
remain a negative factor for the markets.
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) NIfty 50 may move in a
large range of 9730-13111 during 2020. It may return + 8% return during
the year. Overall Nifty 500 may outperform Nifty 50. The risk reward in Nifty
50 is clearly negative.
(b) The outlook is positive
for IT, Insurance, large Realty, IT sectors, and negative for consumers
(especially FMCG and media). For most other sectors the outlook is neutral.
(c) Benchmark bond yields
may touch a high of 7.3%, and average above 6.65% for the year.
(f) Residential real
estate prices may show a divergent trend in various geographies, but may
generally remain under pressure. Commercial and retail real estate may see some
correction.
Key risks to be monitored for the market in 2020
- Material tightening in trade, technology, and/or climate regulations
- Material escalation on northern borders
- Prolonger civil unrest
- Stagflation engulfing the entire economy
- More exits from EU
- One or more Indian states or large PSU failing to honor its debt
On Tuesday I shall present my asset allocation and investment
strategy for 2020.
