Indian large-caps, as represented by Nifty50 index, have been mostly flat relatively or underperformed the rest of the world. While in absolute terms we may say that the Indian markets
have done well, the performance relative to the other world markets
has been worse. This is primarily on account of India’s growth profile being a little worse than the rest of the world’s growth profile. The rest of the world – even those who were hit badly between 2010 to 2015 period – is seeing upward revision in GDP (gross domestic product) growth rates, India has seen negative revisions. I haven’t seen India buck the global growth trend in 30 years. The markets
(large-caps) are reflecting this. Global GDP is growing at 3.8%, the strongest in a decade, while India is growing around 5% or so (old series), which is the lowest growth premium over global growth that India has seen in 2 and a half decades. Ideally, in this very strong global growth environment, India should have been growing 9 to 10%. This is disappointing to say the least. On the other hand, China is trying to slow down its growth!
Corporate earnings growth back home has also been tepid. A lot of predictions have been made that earnings will recover, but the data has not supported the general optimistic view of the Street over several quarters. Going ahead, on a standalone basis, i.e. if we do not compare with the global peers, Indian markets will do well. On a relative basis, however, the large-caps will remain laggards compared to global benchmarks.
What about the mid-and small-caps?
I look at India as two separate markets. One that comprises large-caps and the other that has the mid-and small-caps. I continue to believe that it is the second set that comprises the small-caps that will remain absolutely rocking. The small-cap story remains strong and they remain the best equity class across all global markets. Indian small-caps look terrific, large-caps look average. I have held this view for the past 3 years and nothing compels me to change this view.
Where is this optimism for the small-caps coming from?
There are two reasons. Firstly, just on a relative basis, Indian small-caps are less exposed to things like interest rate tightening and other macro factors, which in India appear to be worsening. Inflation outlook now isn’t benign. Oil prices, too, are headed north and can move up $10 – $15/barrel at least going ahead. All these things will crimp the Reserve Bank of India’s (RBI’s) ability to tinker with rates. We do not expect rate cuts going ahead at all for the next 12 months. On the contrary, there can be a rate hike.
Large-caps are susceptible to macro changes – good or bad. For small-caps, macro factors don’t really matter much, as they are not exposed much to the vagaries of global macros. They are more driven by micros of their own businesses or own sectors.
Over the past few years, most small-cap business owners have realised that it is better to run a good and clean business rather than do things to please the markets, as was happening in 2006 – 07 when people were doing business for vanity metrics, such as order books, doing business without much cash flow etc. This has now changed and good companies / promoters are generating a healthy return on equity of over 20%.
Do you see the key macros worsening over the next one year?
Yes, macros for India in 2018 will be a little worse than in 2017. This comes from the belief that inflation will not cool off anytime soon. Commodity prices, especially crude oil, across the globe have hardened. Oil’s bear market is probably over. Issues related to Saudi Arabia are all hinting at a further upside in oil prices. Higher spending and rising oil prices will impact the twin deficits – fiscal and current account deficit (CAD). In case the government does not wish to see fiscal deficit slipping out of hands, it will have to cut spending. Either way (cut in spending or letting fiscal deficit rise), it is not a good situation to be in. We could be looking at a twin deficit situation of 6% or so, the highest since taper caper of 2013.
How are the foreign investors viewing India now? Do you see incremental money getting deployed here?
India will get flows. One must realise that the other markets, such as Brazil, Japan etc are doing well on growth parameters. Improving economic fundamentals appear more attractive to FIIs than the India story. I don’t think flows into the market will change how the market will behave. It is a futile exercise to see where incremental flows will go. Things can change very quickly. If the outcome of the state elections scheduled for 2018 are pointing towards a problematic 2019 (when the general elections are scheduled), FIIs will remain on the sidelines. Money flows are near impossible to predict.
How comfortable are you with the valuations at this stage?
It is my belief that valuations globally have trended up, and in line with that India has also moved higher. I don’t believe that the world is heading for a bear market in anytime soon. Though valuations back home may appear stretched, the fact is valuations here will not contract on their own, unless there is a global contraction.
Which sectors, in your opinion, will do well over going ahead?
We have been bullish on the chemical sector. Wherever China is cutting back on production due to environmental concerns, those sectors are likely to do well. I continue to be bullish on the steel sector as well. Overall, the commodity space looks good.
I would rate consumer discretionary as average. If you look at the auto sector, however, it continues to remain strong and we have been bullish on it for quite a while now. India is still very underpenetrated in terms of automobile ownership. Irrespective of the macro part, there is a natural demand that will come through for this sector going ahead. Pure consumer / fast moving consumer goods (FMCG) sector is debateable. Some stocks do appear overvalued here. Infra selectively has been good and I continue to like this space, especially the companies that are now fixing their balance-sheets.
What about banks?
I don’t have a strong view on the banking sector. That’s not a sector where I believe a large amount of money will be made. The private sector banks still look okay. As regards the public sector banks (PSBs), however, the recapitalisation by itself was not the problem alone. The issue has been growth as well – and that I don’t see getting resolved. There are no chances of a large-scale capex cycle revival in India. Banks will not make money by an increase in their capital, but will have to lend to grow. If there are not enough projects coming through, the growth will remain a challenge.
What’s your view on corporate earnings growth in FY19?
We have the general elections scheduled for 2019. So in that sense, the government will give some freebies and sops to the sectors that have lagged growth – primarily the rural sector. This can give a fillip to consumption numbers, which could translate into good earnings for India Inc. This is assuming there is fiscal room for such a spending.
What’s your advice to investors going into 2018?
The single advice I would like to give is that India remains a bottoms-up stock pickers market. Investors should ignore all the noise around elections, policies of global central banks, global macros etc and spend some time researching stocks before and do bottom-up stock picking. There are a number of good stories available. In case they can’t, trust a fund manager, buy some small-caps funds and stay invested. Both strategies will do well over a period of time. Buy 10 good stocks and you are set for a lifetime!