The Indian equity market faces a lot of uncertainty in 2018 related to macro, earnings and politics. This makes it very hard to take a concrete view on the market over the next few months. We expect a moderate 8-10% upside for the market in 2018, in case the key macro variables were to turn favourable over the next few months and earnings were to meet with the Street’s high expectations.
The Indian market at 17.3X FY19 earnings has limited scope for re-rating in the context of rising global bond yields and domestic macro and political uncertainties and the market’s current high valuations (despite the recent moderate correction) do not fully capture the deterioration in the macro over the past six months.
It is also possible that the macro factors worsen further, which will weigh on market multiples resulting in low to negative returns for 2018. The bond market seems suitably concerned about the weak macro, as can be seen in the sharp increase (about 125 bps based on 10-year G-Sec yields) in bond yields over the past six months. Earnings yields have barely budged over the same period. The equity market perhaps expects; (1) an improvement in the macro-economic conditions after the deterioration over the past six months, (2) strong 20% increase in FY19 earnings for the market and (3) favourable outcomes of state and general elections over the next Nine to 15 months.
The macro-economic variables are simply too uncertain—things could improve or worsen from current levels. The Indian market will have to contend with three big macro-economic variables over the next few months — GST revenues, inflation and crude oil prices.
If GST revenues fail to pick up over the next few months to match the government’s overall target of Rs 1.1-1.15 trillion per month for FY19, the bond market concerns about fiscal slippages and government borrowing for FY19 may increase leading to higher bond yields. However, if GST revenues pick up meaningfully, then bond yields may cool off. Current monthly GST revenues at Rs 860-900 billion are meaningfully lower than the required monthly run rate for FY19.
If inflation was to surprise negatively (higher than expectations) as a result of weak monsoon and steep increases in kharif MSPs, the RBI may be forced to raise rates, which would be a big negative surprise for the market. We (and the Street) expect inflation to taper down in second half of 2018, which would obviate the need for rate increases by the RBI.
If crude oil prices move up to $70/barrel (or higher), we would see further pressure on current account deficit (CAD)/BoP and the rupee. We expect India’s FY19 CAD to be around $75 billion at $70/barrel crude oil price, which will exceed Foreign Direct Investment (FDI) inflows and bank deposits (around $50 billion per annum typically) meaningfully leaving the BoP exposed to volatile debt and equity FPI flows. However, if crude prices cool off to $60/barrel, CAD/BoP will be more manageable with CAD at around $60 billion.
Earnings uncertainty has increased over the past few weeks following the recent negative developments in the banking system and global trade. We currently expect net profits of the market (Nifty-50 Index) to grow 25% in FY19. However, we see downside risks to our earnings forecasts for banks and metals and mining sectors in case; (1) loan-loss provisions will remain high through FY19 for banks due to further slippages and increase in non-performing assets (NPAs) and (2) global commodity prices will decline as a result of restrictive trade practices by the major economies. We note that banks account for about 45% of incremental profits of the Nifty-50 Index for FY19 and the metals and mining sector another 12%. The next few weeks will provide more clarity on the earnings of banks for FY19.
If the PNB scam turns out to be an isolated incident and there are no fresh untoward incidents, we could see restoration of normal operations in the banking system over the next few weeks. Also, the favourable resolution of ongoing National Company Law Tribunal 1 (NCLT) cases over the next three to six weeks could restore confidence of investors, leading to a re-rating in the multiples of the private ‘corporate’ banks and even PSU banks.
However, any fresh reports of malfeasance in banks could result in further government action against banks, which could affect lending and the fledging economic recovery.
Lastly, the Indian market will have to contend with uncertain politics by the end of this year as the three BJP-ruled states of Chhattisgarh, Madhya Pradesh and Rajasthan going for elections.
It is possible that even the general elections may be advanced to end of 2018/early 2019, which could provide another source of uncertainty to the market over the next few months, as the market will start focusing on the outcome of the general elections three to four months before the elections.
It remains to be seen whether the BJP can repeat its performance of the 2014 general elections when it won 159 of the 171 seats in Chhattisgarh, Gujarat, Madhya Pradesh, Rajasthan and Uttar Pradesh. These states contributed significantly to the party’s majority in Lok Sabha.
Sanjeev Prasad, Institutional Equities, Kotak Securities Limited. Views are personal