New challenges are facing the economy as we turn the year – Tepid food inflation is an indirect indication of the stress in the rural / farm sector. Large MSP increases that were announced this year have not had much of an impact. Disruptions in the NBFC sector can impact flow of retail credit – given their disproportionate presence in that space.
Also with general elections approaching, there are risks of government taking populist steps that put fiscal targets at risk. Despite all challenges, however, we expect the economy to continue to build up momentum primarily driven by consumption demand and improving capacity utilisation is likely to lead eventually to a pick-up in domestic capex.
Growth environment is also supported by low inflation that is putting off pressure for rate hikes as well as a sharp fall in commodity prices including – most importantly – crude oil. The banking system is slowly but surely getting back on its feet as incremental NPLs have started to come off and some of the pending big ticket cases have started getting resolved through the NCLT process. The government has continued to push on improvements in ease of doing business and competitiveness indexes which is helping India attract the attention of global capital flows.
The local economy showed clear signs of a pick-up in growth – although the revival was not as consistent or broad based as had been expected at the beginning of the year. This reflected in continued disappointment in earnings growth for the broader market.
Capacity utilisation at 5-and-a-half year high: Buoyant consumer demand and heightened manufacturing activity in the economy has led to the highest capacity utilisation in five years. Dearth of capital expansion stemming from over expansion in the previous business cycle has been a drag on the industry grappling with large unused capacities and tepid demand. Streamlining of regulatory framework and improving business sentiments domestically has corrected years of demand supply mis-match. The high operational gearing in this industry is likely to aid corporate profitability going forward as companies effectively manage marginal costs and capital allocation.
Ease of doing business: India has jumped 65 places since 2015. India witnessed a 23-notch jump to a record 77th position in the World Bank’s latest report on the ease of doing business that captured the performance of 190 countries. The country showed an improvement in six of the 10 parameters, having witnessed a leap of 129 notches in the ever-laggard ‘construction permit’, 66 in ‘trading across borders’ and 19 in ‘starting a business’. The country’s rank under the current NDA government jumped from 142nd in the World Bank’s 2015 report (which reflected reforms undertaken mostly up to May 2014) to 77 now. The move in the rankings has been the sharpest by any country.
Digital transformation: The advent of affordable smartphones and fast 4G networks has revolutionised connectivity over the last couple of years. India now has the world’s second-largest internet user base. Further, it is a leader in mobile internet usage, with close to 80 per cent of its web traffic accessed through mobile phones (as compared to around 55 per cent for China and a global average of 50 per cent). This is giving rise to unique mobile-first business models and is reshaping industries, including e-commerce, entertainment and the sharing economy.
Technology is also allowing for dramatic changes to the payments infrastructure. Aadhaar provided the framework for the launch of a national digital payment system – the Unified Payments Interface (UPI) that allows users to make money transfers with their mobile phones. In a country where cash has been king, mobile-based digital payments are completely changing the landscape. Since its launch, UPI has shown rapid growth and will start to allow all sections of the population to participate in the formal economy.
Currency turmoil: Five years after the previous episode, India once again found itself in the cross-hairs of global currency market turmoil. The rupee faced a burgeoning US dollar depreciating ~15 per cent before stabilising towards the end of the year. The year-end ‘Santa’ rally coupled with a plunging crude gave the government much needed breathing room.
The rupee had rallied sharply during 2016-17 and as a result had become overvalued in REER terms. The over-valuation started reflecting in some loss of competitiveness for the economy – as evidenced by a rising current account deficit. This coupled with the rising US rate cycle, a broader sell-off in Emerging Markets, rising crude oil prices, and an overall risk-off sentiment, precipitated the sell-off in the rupee. A notable feature is that while the sell-off has been sharp against the US dollar, in relative terms, the rupee maintained its strength.
In fact, the extent of the out-performance during 2016/7 meant that despite the current sell-off the INR remains one of the top performing EM currencies over the last 5 years.
Electoral reversals: One year is a long time in politics. The ruling NDA had consolidated their position in 2017 with wins in several key states including UP and Gujarat. However, 2018 saw them losing power in MP, Rajasthan and Chhattisgarh as well as missing out narrowly in Karnataka. As the year draws to a close, the opposition is getting more vocal on creating a grand alliance to take on the NDA in the general elections and the elections seem more open than what observers were expecting last year. The first half of the coming year is likely to see a lot of political noise as markets and players try to figure out which way the wind is blowing. From the market’s perspective, it is generally seen that a verdict which gives clear majority to any dispensation is always preferred over a fractured verdict that has the risk of policy paralysis. Although it is also true that the impact of election results tends to be more short term in nature and invariably gets overshadowed eventually by the state of the economy and earnings growth.
Style performance: Quality outperformed value during the year. Political and macroeconomic uncertainty drove investors to perceived safe haven stocks through the year creating a clear demand for fundamentally sound stocks with strong earnings growth and niche business models. A style analysis of gainers and losers shows quality stocks outperforming value stock styles during the year. The performance has been a common theme even on longer term performance tenors over 3 years and 5 years.
At Axis MF, since inception in 2009 our investment philosophy has focused on quality companies as an underlying theme while building and managing portfolios. We primarily follow bottom-up stock selection approach with a minimum 2-3-year view on stocks. Bias towards sustainable growth and strong fundamentals are the key lookouts for our fund managers in identifying investment ideas.
This steadfast adherence to quality has reflected in our equity fund performances over the medium and long terms. Coupled with our investment philosophy our brand focus on responsibility also plays a key role in our commitment to investors and stakeholders. Our commitment to responsible investing is imbibed into our research process through continuous monitoring of portfolio stocks and interacting with company managements periodically to understand the nitty gritties of our portfolio companies while constantly evaluating/re-evaluating our investment case for these companies.
While news drove markets this year, quality companies remained a standout performer for the year. We anticipate that quality will continue to remain a resilient performer on account of strong underlying fundamentals. As the saying goes, stock prices are slaves to corporate earnings. The market has differentiated companies who have consistently performed despite short term market sentiments.
Fixed income outlook: We do not believe that there is a material risk of financial instability and hence the RBI is likely to continue to focus on inflation trajectory. With the current inflation trajectory and RBIs inflation projection for the year at 4 per cent, we don't see significant moves on the repo rate front for the rest of the financial year.
As the shadow of the IL&FS saga and the NBFC liquidity crunch recede, 2019 is likely to be a better year for debt against the backdrop of lower crude and stable macros. However, the fiscal position is likely to remain an overhang given that current GST collections are far lower than budgeted expectations and non-tax revenue growth continues to remain tepid. Also, the surprise exit of the RBI governor is likely to add to short term uncertainties as the market awaits the policy changes of the new governor.
Currently, the curve offers significant opportunities from investment perspective as markets are pricing in more than 1 hike till March 2019. Corporate bonds in the 1-3-year space currently trade at a premium of 200 bps over the operative rate which we believe offers material opportunities and hence prefer this space.
Source: Axis Mutual Fund