From Budget 2017, the BSE added an incremental market cap of around Rs 42 trillion as on January 23, 2018. Hence, this crash was waiting to happen and the imposition of long-term capital gain tax became the excuse.
The year 2018 is set to witness several uncertainties or unfavourable developments – recent steep recovery in oil prices and also firming up of prices of many metals and resources would apply pressures on the corporate margins and also on the country’s import bill. Interest rates are likely to tighten consequent to spurt in imported inflation and also recent Budget proposal to hike minimum support prices for the farmers. For the last two years, we had a near-normal monsoon. Once in 3 or 4 years, we had a major failure of monsoon in the last few decades. Therefore, if rainfall forecast (expected in a couple of months) projects dismal performance this year, then inflation expectation could rise further. Fiscal deficit target is likely to be missed for FY2019 – marginal increases in both capital receipts and effective revenue deficits as projected by the Budget are way below the actual increases in FY2018 (RE) over FY2017. Added to this is political uncertainty emanating from the assembly elections for few major states by end of this year.
Don't panic, don't sell good quality stocks
What do investors need to do now? Do not panic and sell good quality stocks (in terms of quality of management and balance sheet) provided valuation comfort is attractive. However, a large number of stocks in the small and mid-cap (SMC) space still remain over-valued – many stocks in this space trade at over 25 to 30 times projected one-year forward earnings, which are more than 100% of their recent historical averages. Hence, as these possible risk factors/uncertainties gradually unfold, we can expect a large number of retail investors getting rid of such over-valued SMC stocks in quickest possible time.
However, the medium to long-term outlook still remains very attractive for both Indian economy and equity markets. Tailwinds from the global economic cues remain highly positive. Significant recovery in the GDP growth rates of the economies of US, Euro area (except the UK), Japan and Russia, and also stability in the growth rate of China (as opposed to fear of hard landing of its economy) augur well. Beyond 2018, oil price is likely to crack – soon US is likely to emerge as a net exporter of oil and there are reports of even Canadian sand oil producers restarting their productions. On the domestic front, export and banking credit growth rates have turned into double digits recently. Budget’s boost to rural spend would push up, to a considerable extent, aggregate demand in the system. Bad assets of the banks are likely to peak by March or June 2018. FDI flows remain robust and earnings from foreign tourist arrivals growing at quite an impressive rate. Also reform initiatives undertaken (GST, FDI policies, etc), massive push to rural infra, roads and regional airports, and thrust on private and public sector companies for spurring manufacturing and infrastructure investments (as the Budgetary support is projected to grow in poor single digit in FY2019) would start pushing up both economy and the stock markets eventually by end of 2018.
Sensex may rise just 5-10 percent in 2018
Meanwhile, the Sensex / Nifty could at best rise 5% to 10% in the whole of 2018 due to other uncertainties listed above. However, the small and medium cap (SMC) space would continue to face severe downward pressure in the short term. Hence, the best strategy would be to quickly exit from overvalued SMC stocks and tilt towards large-cap stocks to the extent of around 50% of total portfolio. Wealth erosion in the large-cap stocks is only marginal in the last 8 trading days as compared to SMC stocks. FIIs, who largely missed the mega rally in the markets in 2017, ish likely to prefer the large-cap stocks as many of them are still trading at a significant discount to the valuation multiples of their peers in the SMC space.
What should investors do?
Sit on cash to the extent of 5% to 15% at least for a month or two till the market stabilizes. Balance 35% should be invested in good quality SMC stocks, which are not outliers in terms of deviation of their current trailing PE multiples from their recent historical averages. For those outliers especially in the SMC space, further corrections in the stock prices would be very steep. As uncertainty unfolds gradually and significant correction is largely done in overvalued SMC stocks, the retail investors can tilt towards the SMC space once again beyond the suggested 35% of equity portfolio exposure to reap rich rewards in 2019. The major risk to this view is any possible shock from the verdict of any possible early Lok Sabha elections.
G Chokkalingam, Founder & Managing Director at Equinomics Research & Advisory