Market to keep moving in narrow range
The Street will be focusing largely on the outcome of the general elections

Indian market has been moving in a very narrow range with heightened volatility over the past few weeks. And this trend is likely to continue for a while as macro-economic and political risks looms large.

As the Narendra Modi government’s term winds down the market will be focusing largely on the outcome of the general elections.

Many analysts are painting a bleak picture. Last four years’ aggregate Nifty EPS growth (TTM) has been lower single digit despite favourable policy environment and stable macro-economic conditions supported by domestic demand.

The market was expecting 15 per cent and 22 per cent growth in Nifty50 EPS for FY19 and FY20, respectively. But the actual EPS growth in H1 is about 8 per cent and given a slowdown in business in H2, this expectation will taper to sub 10 per cent and 20 per cent in FY19 and FY20, respectively. Additionally, global headwinds and general elections may keep market under pressure in the near term, analysts said.

The index rallied 75 per cent (since May 2014) fuelled by a rise in risk premium backed mainly by local retail investment funds on hopes of better days.

A PE cycle mean reversion will lead to painful price and time correction.

The equity risk premium, or PE expansion of last four years, has lifted the long-term average PE itself and sustaining above 23x since Feb 2017; unprecedented in the last two decades of multiple PE cycles. Even one-spectrum lower rating gives Nifty target of 9,400.

“We are sensing some nervousness among the foreign as well as retail investors in the near term. In our view, global economic slowdown, crude prices and upcoming general elections are likely to be the key factors for market direction. That said, investors with a longer term perspective should utilize sharp drawdown in market levels to build positions in quality stocks,” Sanjeev Zarbade-VP-PCG Research, Kotak Securities.

The reason for the relentless rise, or resilience, of the Nifty, despite about 80 per cent of stocks quoting below their respective 200 DMA and over 20 per cent down from peak in August 2018, is that funds are chasing the index and within the index they are chasing only the stars.

Funds, insurance are receiving retail flows and fund managers want to deploy only in performing stocks that has limited their investment basket to comprise index stocks. Fund portfolios show 60+ per cent of corpus is going into Nifty 50 stocks. For anything outside this basket, fund managers have to obtain special permission from their investment committees. The mid-caps segment is already in bear market territory with losses ranging 20-40 per cent from peak levels.

Within the index, they are deploying more funds in top six companies having 50+ per cent weightage in order to mimick index returns. This is like self-fuelling fire. No one knows when will it cool. When it does, many are going to get burnt badly. It’s only a question of when, not if.

Meanwhile, FII outflows totalled $214 million for the past five days, while DII inflows in the same period stood at $195m.

Macro stress has started showing. Fiscal deficit 114.8 per cent of the full-year target of Rs 6.24 trillion at the end of November on account of lower revenue collections (read GST shortfall), would cap market gains. Bonds may also see sell-off.

Fiscal deficit is set to exceed 3.3 per cent  (it already has) or the government may resort to drastic cut in spending, which it had kept as a wild card ahead of the general elections.

Despite claims of PCA banks recap programme, full-fledged lending by them would wait, possibly until 2Q’19 after new government is in place. USD/INR likely to see renewed pressure, as forecast earlier, on recent a rebound in crude oil prices.

Corporate earnings growth is missing for the last four years (as during NDA 1999-2004) The Nifty remains in higher PE band, hanging 2+standard deviation above long-term average valuation bands competing with stocks as Nifty earnings Yield is less attractive on rich valuations.

Greed backed by the local fund flows (retail SIPs, ETFs) have supported Nifty sustain more than 2 standard deviations above long-term mean valuation for an extended period, unseen in the past two decades.

The spread between Nifty earnings yield and 10-year G-Sec has widened to the 3.5 per cent, level where bonds compete strongly against equities in smart investors’ portfolio.

Nifty and USD-INR shared inverse relationship till 2013; INR strength brought Nifty gains and vice-versa. This broke since early 2013. Nifty has moved up (doubled) since then and INR depreciated 40 per cent against USD hurting foreign investors’ total returns.

This again coincided with large-scale outflow of foreign funds from both equities and bonds that were more than matched by local savers who may now be keeping their fingers crossed. Though all believe economy and corporate earnings will improve irrespective of whichever party comes at the Centre.

Evaluating various scenarios, the risk-reward looks unattractive for India market, but best for private corporate lending banks (especially those with retail liability franchise), rural-focused names and IT,” said UBS in a note authored by Gautam Chhaochharia.

“It is also unattractive for small and midcaps (SMIDs), infrastructure and industrials.”

According to the foreign brokerage, the Nifty50 index is likely to hover in the range starting from 8,200 on the downside and can go upwards till 11,900 on the upside, which means a new record high for the index is possible.

Analysts expect political uncertainty to be a negative overhang in the first half of 2019 but according to them falling oil prices have created a positive environment for the market.

Staying in cash and waiting for the right opportunities to come by could prove rewarding in 2019 that’s likely to be more volatile than 2018.

Ashwin J Punnen