Playing The Stock Game
Every Diwali, we ask our favourite stock analyst one question: what is the outlook for the next Samvat? And every year, we muddle through a half-baked projection that has equal chances of being a hit and a miss.
So, let's see what analysts are predicting for the next year. But wait! Does it matter? Not really, say some of the world's best investors - as your returns will not depend upon your playing or not playing the numerical guessing game but on how well you manage risks while investing your money. Markets, they say, will keep moving up as well as down, and second-guessing their movement is well nigh impossible. The only thing an investor can do is to keep risks under control while going for the best possible results.
"It is the nature of markets to be volatile; you can't avoid that. One must learn to stomach volatility and focus on avoiding risks. This is what all great investors do," says Dhananjay Sinha, Head of Research, Economist & Strategist, Emkay Global Financial Services.
Mind the Risk
This view was made popular by legendary investor Warren Buffett. However, for proof, one needs to look no further than the 2008/09 stock market crash in India, when the Sensex fell from 21,000 to 8,000 between January 2008 and March 2009. This took a huge toll as scores of small investors, charmed by previous years' bull run, started investing at the peak on the basis of stock tips and analysts' views, which were at that time one-sided and bullish in the extreme. As the party went on, steps were not taken to reduce risks in case it was busted. And busted it was. Stocks such as Unitech, Aban Offshore and Suzlon Energy - the hot picks that analysts did not tire of peddling, ignoring the risks of humongous debts and overstretched valuations - slid 92-95 per cent. Even now, Suzlon Energy is trading at Rs 14.70; it was at Rs 454 around the market peak. Unitech is trading at a discount of 99 per cent (Rs 5.70) from the peak while Aban Offshore is 95 per cent down at Rs 258.30.
Those who did not ignore risks and also bought stable, yet attractive stocks, such as FMCG major Godrej Consumer Products, also got hit by the broad market fall but recovered. Godrej Consumer Products fell only 6.89 per cent, while Hero MotoCorp (then Hero Honda) and GSK Pharma rose 35 per cent and 10 per cent, respectively, between January 2008 and March 2009. Over the next seven years, these stocks have given fabulous returns. So, what can retail investors expect in the new Samvat? Some volatility? Well, undoubtedly. But great returns, too, say experts.
"India is in a Goldilocks situation, the best of multiple choices," says Vinay Khattar, Associate Director and Head of Research, Edelweiss Financial Services. We discuss what will drive India's stock markets in the coming year.
Global Factors
While a smart investor always factors in a degree of volatility due to global factors, experts say Indian stocks may be comparatively more insulated on this front than others. The reason is the macroeconomic stability that India has been blessed with over the past couple of years. Not only will it be the world's fastest-growing economy this year, what is even more impressive is that it has been growing without putting a lot of pressure on its finances -its deficits, both current account and fiscal, are well under control.
At present, whatever volatility it is facing is mainly due to global factors. Jigar Shah, Chief Executive Officer, Maybank Kim Eng Securities, says, "Volatility in Indian markets is largely linked to global factors such as the recent panic over Brexit." Nilesh Shah, MD & CEO, Envision Capital, says, "Global factors are driving the volatility back home." About the outlook for the next few months, he says, "Over the next two-three months, Fed meeting in December, US presidential elections and problems in the euro zone will be the key factors to watch out for." The US Fed meeting might result in a rate increase, triggering an outflow of funds from emerging markets to the US.
Domestic Triggers
A number of local factors are favouring Indian stock markets. "The policy environment is positive. Growth is expected to accelerate. In this backdrop, risks to equity markets could emanate more from global factors," says Bharat Iyer, Managing Director, Head of India Equity Research, JP Morgan.
Several broking houses, such as Edelweiss Financial Services, echo the opinion of many brokers on Dalal Street that the bull market that started in mid-2013 is continuing. "We are still in the early stages of the bull market. Most of the growth is yet to come. The bottom-line growth of many companies has been negligible for the past six-odd quarters. We believe that is set to change," says Khattar of Edelweiss.
Favourable Factors
Good monsoon/robust economy: The impact of a favourable monsoon has starting reflecting in lower food prices. This will help inflation fall from the second half of 2016/17 and, thus, increase consumption and encourage the Reserve Bank of India, or RBI, to cut interest rates. Crisil Research says all this will push up rural incomes and boost private consumption by 90 basis points, or bps, this financial year, ensuring that the country's gross domestic product, or GDP, grows 7.9 per cent in 2016-17.
GST Bill/Curbing of corruption: The implementation of the Goods and Services Tax, or GST, is expected to help companies by simplifying the indirect tax structure and add substantially to the country's GDP. It will also plug tax leakages to a large extent and help the government earn more tax revenue. The size of the black economy may shrink as a result. To top it up, steps such as opening up more sectors to foreign direct investment are helping the country get record investments.
FII inflows/Global factors: In the absence of other triggers such as earnings growth, markets in India have been largely driven by liquidity, both domestic and foreign. Foreign institutional investors, or FIIs, have pumped in over Rs 47,859.6 crore in equities since January this year. Experts say the trend is getting stronger with each passing day. Until the next Samvat, the pace of inflows should continue, they say, with the only caveat being geo-political risks.
Seventh Pay Commission: The government recently increased the minimum basic pay of one crore Central government employees/pensioners across the country by around 23.5 per cent. More money in their hands is expected to push up spending on discretionary goods and services and stimulate economic growth.
Consumer demand: There has been a strong recovery in demand for passenger vehicles, air traffic and fast moving consumer goods (FMCG), say analysts. "Urban demand has seen healthy growth. Margins and top lines would grow and we could see high-single-digit volume growth over the next few quarters," says Jigar Shah of Maybank Kim Eng Securities. This will, in all likelihood, reflect in bottom lines of corporate India.
India Inc Earnings: In the first quarter of 2016/17, India Inc reported 5 per cent year-on-year revenue growth, compared with stable growth in the first quarter of 2015-16, says CRISIL. "However, an analysis of the performance of 500-plus companies across 50 sectors (excluding financial services and oil & gas) in the quarter to June 30, 2016, shows that the growth was lower than the 7 per cent increase in the fourth quarter of 2015/16. While the revenue of export-linked segments grew 12 per cent, those related to consumer discretion and investments posted 8 per cent growth," it says.
CRISIL Research says key sectors' revenues will grow 7 per cent in the second quarter of 2016/17 compared with marginal growth of 2 per cent in the second quarter of 2015/16. "Aggregate growth of the set will be driven by some major sectors, including automobiles, IT services and pharmaceuticals. While the IT sector is estimated to grow in double digits, automobile and pharmaceutical are expected to see significantly higher growth compared to last year," it says.
"The year 2017/18 should see double-digit growth. Chances are that it will be driven by good GDP growth rate. Both engines of growth - urban and rural consumption - should fire simultaneously over the next 12 months, giving a huge boost to corporate earnings," says Shah of Envision.
Dhananjay Sinha of Emkay, however, questions if such earnings growth will be sustainable or not. "Expectations are exceeding reality. Corporate tax collections are poor. Incremental liquidity might be lower as the European Central Bank and the Bank of Japan buy fewer assets. The Fed, too, might be normalising rates. All this means modest earnings growth and a range-bound market."
OTHER RISKS
Execution: Be it road, railway, power or any other infrastructure project, execution is always a big risk. Even though the policy environment has been conducive for business over the past six months to one year, even a tax reform as important as the GST is clouded by doubt, especially over the main rate that the country will adopt. "A tax rate of more than 18 per cent will hurt corporate profitability," says Jigar Shah. It will also be inflationary. There are also talks that the final structure of the GST might turn out to be much more complicated than envisaged.
Low Private Capex: While government capital expenditure has risen, private investment, say economists, may remain subdued in the short term due to low capacity utilisation and high corporate debt. There are also concerns over the bottoming out of government capital expenditure, though Bharat Iyer of JP Morgan says this is unlikely. "The government's fiscal arithmetic appears to be well-anchored. Revenue collections under individual heads could disappoint but the overall numbers appear credible. Consequently, the investment spending might be in line with forecasts," he says.
Global Economy: The IMF 2016 World Economic Outlook marked down the 2016 growth forecast for advanced economies to 1.6 per cent. It said global growth would decline to 3.1 per cent and then rebound next year to 3.4 per cent. "The 2016 forecast reflects weaker-than-expected US activity in the first half of the year as well as materialisation of an important downside risk with the Brexit vote," says the report.
Not just this. It pointed out concerns over recessions in Nigeria and South Africa due to low commodity prices and difficult political/economic conditions. Among the BRIC countries, it said, Brazil and Russia continue to face difficult macroeconomic conditions, though their outlook has brightened from last April.
Alhough JP Morgan says India is a consensus overweight market, Bharat Iyer warns that "given the dependence on external capital, any disruption in global financial markets is a key risk to watch out for."
This is not all. "Key risk factors we would watch out for include any V-shaped recovery in global crude oil prices, given the adverse impact that could have on macroeconomic variables," says JP Morgan.
Next Triggers
In spite of the poor momentum in advanced economies, India is poised for decent growth. The triggers are likely to be the RBI's credit policy, which has been turning more accommodative. In December, we would know if we would have a further rate cut which, of course, would also depend on the US Fed stance in winter. A rate increase in the US may force the RBI to maintain status quo for some time to ensure there is no sudden outflow of funds as a result of the Fed action. "A cut in interest rates will have a beneficial effect. Demand will increase by 10 per cent over the corresponding period of last year and earnings could improve by 20 per cent," says Arun Firodia, Chairman, Kinetic Group.
Many on Dalal Street are pinning hopes on revival in earnings growth as a trigger. "The broad market has been re-rated to about 18 times estimated forward earnings due to better policy environment. The base for the revival in earnings has, therefore, likely been set. Profit margins have started trending up," says Iyer.
Roll the Dice
So, while markets take cues from domestic and global factors over the coming months, should the retail investor be biting his nails, folding up his portfolio or getting ready to roll the dice? Nilesh of Envision Capital says the market has not topped out yet and there is a lot of room for earnings to grow.
This time, though, the rally does not look to be sector-specific. There is disruption happening in most sectors and one needs to pick companies that look likely to benefit from the growth in the economy. Bharat Iyer of JP Morgan says, "Most segments should do well given the expected pick-up in the economy. But a few themes stand out. Urban consumption should benefit from the implementation of the 7th Pay Commission recommendations."
"Financials should benefit from falling interest rates, though one still needs to be a tad selective in the backdrop of credit cycle-related issues," he says.
Dhananjay Sinha of Emkay says, "A rate cut will be positive for banks but for investors in banking stocks return on assets has diminished. Rather, companies engaged in capital goods and consumer durables should be the ones that investors must watch out for."
Given the attractiveness of broad sectors related to urban and rural consumption - FMCG, telecom and data, infrastructure, consumer durables and some mid-cap realty stocks are good places to invest due to their linkages with India's economy. However, a close study of valuation is imperative. While you mitigate risk and ride the volatility, get ready to expand your equity allocation.
