The Year That Was, and Outlook for 2019

  • 10th Jan, 2019

If one were to look at how the markets closed this year, it would appear to be an uneventful year, as the equity market returns (indicated by benchmark Nifty 50 index) were flattish.  And even for the debt markets, the 10 year benchmark bond yield closed on a flat note, with bond funds delivering subdued returns. However, in reality it was a volatile year, with a roller coaster ride in both the equity and debt markets.

Even though the Nifty 50 index closed on a flat note, the small/mid-cap space registered a significant correction during the course of the year. Therefore the market breadth was largely negative, and even in the large cap space, it was a narrow market—with only a handful of stocks contributing to most of the returns of the benchmark Nifty 50 index during 2018– led by IT, select private financials and consumer companies. However, despite the market volatility, India was a relative outperformer amidst global markets in 2018—particularly with some markets registering a deep correction during the year.

The debt markets suffered a set-back and saw a credit squeeze, due to the default of one of the large infrastructure lenders. The benchmark 10 year bond yield rose from 7.3% at the start of the year to peak at around 8.2% in September 2018, and then fell sharply to close the year near the 7.3% mark again, as the interest rate and credit environment improved.

Some of the earlier headwinds turn into tailwinds

Crude falls sharply: One of the biggest headwinds for the Indian markets and economy was rising crude oil prices. India is a large net importer of oil, and oil imports account for around 80% of domestic oil demand and a significant portion of our trade deficit. Brent crude oil rose from $67/bbl at the start of the year to above $85/bbl in beginning of Oct 2018, and then fell sharply to around the $50-55/bbl mark presently. The sharp fall in crude prices has been helped by easing sanctions on Iran, unwinding of long speculative positions, significant increase in crude production particularly from the US, and expectation of some slowdown in global growth. This sharp fall in crude prices helps to mitigate some earlier concerns of rising current account deficit (CAD), and also inflation to some extent.

Rupee recovers from its life time lows: The rupee had weakened from 64/USD mark at the start of the year to life time low of around 74.5/USD in Oct 2018, and has now recovered to around 70/USD presently. This has been on the back of sharp fall in crude oil prices, reversal in foreign outflows, and a general recovery in most emerging market currencies.

Bond yields soften considerably, providing some relief to the debt markets: As mentioned before, bond yields have also fallen sharply from its peak of 8.2% to around the 7.3% mark presently. This has been on the back of recovering rupee, liquidity infusion by RBI through OMOs, falling inflation, the recent dovish stance by the RBI, and increased market expectations of some monetary policy accommodation (as opposed to calibrated tightening earlier).

Credit & liquidity crunch eases: The default of infrastructure financer IL&FS spooked the bond markets in Sep/Oct 2018, and also led to turbulence and drying up of liquidity in the NBFC / HFC space. However, the credit and liquidity crunch has somewhat stabilized now, and as a result CP/CD yields have also eased from their recent highs.

Foreign outflows see some reversal: After seeing large outflows in the past few months (due to global risk aversion and a weakening rupee), we have seen a reversal in the months of Nov – Dec 2018, with foreign portfolio investors registering net inflows both in the equity and debt markets. Meanwhile, domestic flows into the equity markets continue to be robust, and have countered the FII outflows this year.
Valuations have become more reasonable: After the recent correction, valuations (P/E) have become more reasonable in the large cap space. Select stocks in in the mid/small-cap space also look attractive.

Outlook in 2019:
Corporate earnings have been on a recovery path, although slightly below expectations.  We believe that corporate earnings growth will accelerate in H2 FY19 and particularly in FY20, and this should be the key driver for markets in 2019. Earnings growth over the past years was primarily driven by domestic consumption sectors; but we expect that growth will be more broad-based in 2019. We also feel that the capex cycle (which has been the drag earlier) has now bottomed out. The capex recovery will be more gradual and is likely to pick up pace post the general elections. From a sector perspective, we continue to like well-run private sector banks and NBFCs due to their good asset quality and healthy credit growth. We think that pharma sector, which was struggling due to the US FDA issues and weak pricing for generics, seems to have bottomed out. Also, we are incrementally turning positive on capital goods, on expectations of a capex turnaround–as the industry capacity utilization levels are inching towards optimal.
In the equity markets, we have been preferring the large-cap segment since the beginning of 2018, on a relative valuation basis. Although we still like the large-cap segment; with the recent correction in the small and midcap segment, there are some good selective bottom-up opportunities also emerging in this space. Investors should continue to invest in a staggered manner in equities, and could look to add positions on any large market dips.
The recovery in corporate earnings and economic growth in India should augur well for equities in the long term, however, one needs to be cognizant about the short term volatility in equity markets. Historical data shows that longer the holding period for equities, lower the volatility and lower the chances of negative returns. Besides that, equities has been among the top performing asset classes over the longer term—helping to effectively beat inflation and create wealth for investors. So investors should not get overtly influenced by the short-term market movements—and focus more in achieving their long term investment goals.
In the fixed income markets, with bond yields coming down substantially, we feel that a large part of the rally is behind us now. We expect the debt markets to be range-bound–providing steady returns. Presently, we are positive on the short to medium term part of the yield curve.
Factors to watch out for:
Despite the headwinds mentioned earlier stabilizing, there are certain factors to watch out for, which may cause some intermittent volatility in 2019. On top is the recent turbulence in global markets, on fears of a global growth slowdown. Another factor to note is global monetary policy (particularly Fed), and although US monetary policy has turned slightly dovish recently, any pick-up in pace of monetary tightening by other major central banks may cause some volatility in emerging markets (including India).
The upcoming general elections in 2019 may also cause some volatility and uncertainty, but we expect it to be more short-term in nature. There may be some minor fiscal slippage due to some populist measures (which is usually seen ahead of elections), and lower than budgeted GST collections, but we do not expect a major impact of the same in the long term. Last, but not least, the trade tensions between US & China have stabilized, with US halting further tariffs for 90 days, to allow for talks. But there is uncertainty on the future course of action.
Wishing investors a happy new-year, and happy investing! Remember, that good things come to those who wait—so patience and discipline (sticking to asset allocation) are the virtues of prudent investing.

“The opinion expressed by the Author in this article is his personal opinion and readers are advised to seek independent financial advice before taking any investment decisions”.

Source : Et Market Moguls

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