Market outlook 2018: Key risks to watch out for

The benchmark indices look set to welcome the year 2018 near record-high levels, though rising inflation, oil prices along with fiscal challenges and global risks are likely to pose a threat to the ongoing market rally. 

Thus far in CY17, the markets have rallied over 27 per cent and have been among the top performers globally. 

Here are some key risks that investors need to watch out for in CY18: 

1) Global cues and interest arte cycle 

Some experts believe interest rates may have bottomed out and that the Reserve Bank of India (RBI) may, in fact, hike policy rates in the next calendar year. As the central bank had predicted in its fifth bi-monthly policy review, the consumer price index (CPI)-based inflation has moved beyond its comfort zone of 4%. With the CPI coming in at 15-month High of 4.88% in November, and rising oil prices putting an upward pressure on the same, the era of rate cuts seems to have ended. Besides, geopolitical challenges like spar between North Korea and US will also be a key risk to markets.  

“As inflation continues to tread higher, the risk of MPC tightening its policy stance in FY19 has increased significantly. Inflation outturns in 1HCY18, specifically CPI inflation, will be crucial in assessing the RBI’s next move (and possibly the first signs of a rate hike),” said analysts at Kotak Institutional Equities in a brokerage note. 

2) Fiscal discipline

Markets will also keep an eye on the fiscal deficit target while announcing the Union Budget in February 2018. Any increase from the FY18 target of 3.2% of the GDP could worry markets. Recently rating agencies Moody's, which upgraded its India rating to Baa2 from Baa3, and Standard and Poor's, which kept it unchanged, had also cited an uptick in fiscal deficit as one of the key risks. 

On the other hand, a rise in fiscal deficit on account of spending on infrastructure related projects that will entail long – term benefits for the economy may not be taken negatively by the markets, experts say.

3) Crude oil prices

India has long enjoyed the economic benefits of lower crude prices, but the spectre of rising oil prices is back. Brent crude oil prices rose above $65 for the first time since June 2015. Going by brokerages’ estimates, every $10 per barrel rise in the oil price worsens the fiscal balance by 0.1 per cent of GDP, and every 10 per cent increase in crude oil prices may lead to a 0.5-0.7 per cent increase in WPI, and up to 0.3-0.35 per cent rise in CPI. 

4) Banking sector still to come out of woods 

Banking sector will remain crucial in 2019 to set the tone for entire market. Banking stocks, especially public sector banks (PSBs), recorded a stellar rally late in October after the government announced its mega recapitalisation (recap) plan to deal with the bad loans. However, even before the details could be laid out, banks were slapped with an ordinance to Insolvency and Bankruptcy Code (IBC) that may force them to take larger haircuts on the loans. Street will closely follow any development on the recap and IBC front. 

5) Corporate earnings

The 26% rally in the benchmark indices that we have seen so far in 2017 has not been supported by corporate earnings. The Sensex is trading at its trailing price-earnings (PE) ratio of 24.60, making India one of the most expensive markets. Such valuations suggest that the Street is discounting a sharp recovery next year. Gains will turn out to be limited unless corporate earnings revive in 2018. 

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