For India, financial year 2017-18 (FY18) was historic and lucrative with developments like the indirect taxation overhaul in the form of goods and services tax (GST), decisive policies relating to the insolvency & bankruptcy code (IBC), announcement of bank recapitalisation to the tune of Rs 2.11 lakh crore, sovereign rating upgrade by Moody’s after 14 years; and for the first time the country jumping 30 positions to be listed in the top 100 in terms of ease of doing business ranking.
With that backdrop, the first quarter of FY19 turned out to be a cocktail of macro-headwinds and micro tailwinds leading to split disposition in the market structure with bull market in the Nifty and bear market in mid- and small-caps turning the once optically raging bull into an ageing bull.
While the Nifty is within kissing distance of its all-time high, during the last few months, mid-cap and small-cap indices witnessed 15.3 per cent and 20 per cent correction, respectively, from the recent peak in January.
Consequently, many mid- and small-cap stocks witnessed a sharp fall of around 30-50 per cent from their peaks. About 67 per cent of the BSE500 index companies have corrected over 20 per cent from their 52-week high prices.
Poor quality equity stocks have been decimated (make no mistake, carefully selected quality stocks are still well rewarded by the market) leading to significant wealth erosion in portfolios, truly reflecting the theme of our strategy report in April 2018 – 2018 will be the year separating men from boys.
The abrupt and sudden auditor resignations in few of the popular mid-cap companies; followed by Sebi’s additional surveillance mechanism (ASM) list of about 200 companies accelerated the mid-cap meltdown. Albeit agonising in short-term, the clean-up is good for Indian capital market’s long-term health.
As the foundation of 2014-2017 Indian market rally was the political stability, there is increasing anticipation towards upcoming Lok Sabha elections. In the build-up towards elections, the market will be keenly watching emerging political equations, date of elections and name of the prime ministerial candidate of political alliances. These factors are sufficient to keep the Indian markets volatile in the coming months and quarters.
As India imports 80 per cent of its oil requirements, the vulnerability of Indian macro economy to high crude oil prices is well known. Brief flirting of crude oil price with $80 per barrel has triggered anxiety leading to concerns on inflation, current account deficit, oil subsidy mechanism and dipping of forex reserves (from all time high of $426 billion in April to $408 billion in June).
These are all critical factors in a politically sensitive election year. But towards the fag end of the quarter, Opec decision to increase the crude oil production by 1 million barrel per day has given welcome relief and somewhat comforted the market. This provides critical breathing space to the government in its fuel price policy making and who should take the burden (oil marketing companies – OMCs/exploration companies/state governments through cut in VAT/central government through excise duty cut); along with an all-important strategic question of bringing petrol and diesel also under GST ambit.
As we have highlighted in the April wealth research strategy report, “whichever way one looks at, interest rate cycles have bottomed out and bonds yields set to rise”, the bond markets across the world have played out perfectly to the letter-and-spirit of our view. When we had highlighted in the report that the Indian 10-year bond yields were expected to reach 8.99 per cent by 2020, it appeared as an outrageous view. But in April-June, bond markets have gotten astonished with the ferocity and speed with which Indian bond yields have breached 8 per cent mark. This sharp spike in bond yield has happened despite the fact that RBI tried to pacify the nerves of bond markets with its commentary, signifies that interest rate cycles are predominantly global in nature; and local central bankers can at best delay the process (but can’t deny the process). But towards the end of the quarter, bond yields have cooled off a bit on the back of the open market operations by RBI playing the role of a saviour. But the risks for rebound of bond yields above 8 per cent are very much alive and will unfold in coming quarters.
The US Federal Reserve’s interest rate hikes and unusually strong US economy have strengthened the dollar index leading to breakdown in emerging market currencies, including the rupee breaching psychologically important all-time low levels beyond Rs 69 per dollar. RBI has been aggressively intervening in the forex market to defend the rupee weakness and associated volatility. It’s reflected in sharp dip of forex reserves ($18 billion) in less than two months. With oil prices precariously poised, continued selling by FIIs both in equity and debt markets can see the rupee to weaken further beyond Rs 70 per dollar.
To put things in context, in January-June, FIIs have sold highest amount in equity and debt markets since 2009. The net FII outflow during the period was Rs 47,872 crore – Rs 6,431 crore in equities and Rs 41,435 crore in debt. Further, starting 2009, CY18 is the first time where FIIs are net sellers both in equity and debt.
Even though rupee weakness can help exporters (especially in IT and pharma sectors), the net effect of this is adverse on economy due to huge oil import dependence. But if macros improve and political stability revives leading to FII inflows, there may be much needed support to the rupee.
Corp earnings comfort
In 2014-17, India enjoyed fantastic enviable macros (with very low crude oil prices, comfortable levels of inflation, under-control dual deficits and benign interest rate scenario with accommodative monetary policies across the world). But the Indian micro scenario in terms of corporate earnings was not that comforting during this period with low single digit corporate earnings growth and multi-decade low levels of bank lending growth. But starting financial year 2017-18, while macros have started to face headwinds, there is clear uptick in corporate earnings (albeit in non-BFSI companies). BFSI companies (especially public sector banks) continue to be party spoilers on the back of aggressive asset clean-up drive.
In the fourth quarter of FY18, as per the Centrum Research, net sales of 40 non-BFSI companies (out of the Nifty 50 companies) grew by 16.4 per cent year-on-year, whereas net profit grew by 9.5 per cent. Net interest income of 10 BFSI companies (out of Nifty 50), grew by 6 per cent year-on-year, while net profit declined by 61.5 per cent.
Source: Centrum Wealth Research