Looking forward to 2019

The year 2018 was one tumultuous year for the Indian equity investors, which brought along euphoria as well as despair. Domestic frontline equity indices scaled life highs in early 2018, outperforming the mid- and small-cap segments. Equities initially rallied on positive macroeconomic data, encouraging corporate earnings and robust global trade growth trend. However, faster growth in the US economy triggering concerns of quicker rate hikes by the US Federal Reserve and tighter monetary regime moderated the rally in global equities. The culmination of factors including persistence in global trade conflict, surge in crude oil prices and weakening of the emerging market (EM) currencies against the US dollar dampened global risk sentiments, dragging Indian equities in the latter half of the year. The introduction of long-term capital gain tax on equities, state election-related volatility and weak macroeconomic parameters continued to weigh on domestic equities. 

Tighter global rate regime and an increase in domestic inflation triggered a couple of rate hikes by the Reserve Bank of India during the year. Further, pre-election volatility, weakness in macroeconomic parameters placed a drag on domestic equities. IT, FMCG, banks and frontline indices ended the year positive whereas realty, small and midcap segments lost heavily.

Some key trends defined the year 2018 for Indian market. Corporate earnings improved through the quarters in calendar year 2018 initially on base effect and later, driven by domestic consumption, a revival in industrial production and global demand. Macroeconomic parameters weakened but relatively positive micro indicators supported growth. On the policy front, continued strengthening and implementation of the Insolvency and Bankruptcy Code (IBC) and asset quality clean-up for banks was a positive.

Foreign portfolio investors flows into Indian equity markets for CY2018 were negative at $4.5billion (positive $7.7 billion in CY2017). Domestic institutional investor flows remained robust at Rs 1.09 trillion ($15.6 billion) for CY2018 (Rs 90,830 crore in CY 2017). 

Focusing on India, domestic positives drove equity market valuations high during 2018 despite global risk-off sentiments towards EMs in general. However, the recent correction in global and Indian equities has brought respite by moderating the domestic equity valuation levels towards the close of the year. While global equities continue to adjust to the new interest-rate environment (away from ultra-low rates of post-global financial crisis era), strong fundamentals coupled with moderating valuations bode well for sustainable growth for India. 

Elections in India have always played a significant role in shaping near-term investor sentiments. State elections in this year and general elections just a few months away have understandably lent volatility to markets over and above the global factors. But the rhetoric on competitive populism by political parties on loan waivers, subsidies, reduction in the goods and services tax (GST), unemployment allowances etc, is alarming. If implemented, these populist measures could boost rural consumption, but at the cost of lower funds available for infrastructure and capex growth. Inflation too might rear its head again after being benign for a long period of time. But these are more of risks than the most probable outcomes. Another cognizable risk is the possibility that persistent weakness in global markets in general and continued uncertainty in the Indian markets could affect domestic flows going forward, making Indian equities once again vulnerable to foreign portfolio investment (FPI) capital flows.

Though markets could experience interim volatility in the run-up to the Lok Sabha elections in 2019, on the growth front, the policy reforms undertaken by the government to improve productivity dynamics in the economy — GST, IBC, JAM trinity, improving the ease of doing business, bank recapitalisation, increasing FDI limits across sectors, to name a few, are expected to have a lasting positive impact on economic growth. At present, growth recovery is aided by consumption and exports growth. Prudent policy mix along with a pick-up in private sector capex should further sustain the growth momentum. 

Additionally, as global growth moderates in 2019, pressure on commodity prices and hence inflation in general is expected to stay benign, paving way for benign monetary conditions. India’s banking sector is expected to drive better credit growth as it recovers from a significant provisioning cycle, leading to improving demand conditions. Higher capacity utilisation should lead to corporate capex picking up leading to broader revival in the investment cycle and earnings growth. In summary, we expect 2019 to be a better year for equities when compared to 2018. From an investment perspective, diversified equity funds with core exposure to large caps and prudent risk-taking in mid/small-cap space may be well positioned to capture medium- to long-term opportunity presented by the equity markets.
The author is managing director & chief investment officer, Emerging Markets Equity, Franklin Templeton Investments India

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