2018 was a year of reversals. Globally, most asset classes were in the red due to macro concerns, especially volatile crude oil prices, strong dollar and rising yields. Geopolitical events kept investors on tenterhooks and domestic events such as tightened liquidity and state elections added fuel to the fire. Secular growth in the equity markets seen in 2017 gave way to volatility in 2018 globally, and India was no exception.
Looking forward, in 2019, we should be on a steady wicket and the macro backdrop will become supportive of markets. With the US expected to see a soft landing, we will see a dovish Federal Reserve and dollar strength will start abating. The macro fundamentals for India will be stable with range-bound oil prices, stable rupee, benign inflation, and manageable twin deficits. The tight liquidity situation has also eased off and system liquidity should be back at neutral by March 2019.
India will continue to see steady economic growth with a marginal improvement in FY20E. The key driver will be secular growth in private consumption, supported by investments, particularly in infrastructure.
Private consumption will continue to be on a steady growth path driven by demographics, rising urbanisation and premiumisation, and shift from unorganised to organised. With a large middle class and growing affluent class, discretionary spending will increase going forward. Government stimulus in an election year will give a boost to rural consumption.
Bank balance sheets are getting repaired and credit growth will remain strong as banks step in for non-banking financial companies (NBFCs). Although, the housing sector faced challenges in 2018, reforms such as RERA and affordable housing will drive household capex over the next few years. Government is continuing its investment in infrastructure development, particularly in Bharatmala road projects and Dedicated Freight Corridor railway projects. Capacity utilisation has risen to levels where we should start seeing private capex picking up.
With regards to earnings, even as there would be near-term pain in earnings for NBFCs and wholesale-oriented banks, broader earnings growth for the market will remain supportive. We should see earnings growth of 15 percent compounded over the next two years for the Nifty (excluding corporate banks).
After a strong 2017, we believe 2018 was a year of consolidation in the market. The largecap Nifty index fell around 8 percent from its peak, while the midcap and smallcap indices fell 20 percent and 35 percent respectively. With earnings catching up, valuation multiples, which were fairly high have corrected. The largecap Nifty index valuation at 17-18x one-year forward earnings multiple is 10 percent higher than the long-term average. However, considering the better earnings visibility, largecap valuations are reasonable. An improving growth outlook will drive markets to scale new highs in 2019. We should see returns in the low teens next year.
India and other emerging markets now offer favourable risk-reward amid improving growth, supportive macro, healthy balance sheets, light investor positioning, and reasonable valuations. Consequently, we will see a reversal of the foreign portfolio investment (FPI) outflows that took place in 2018. In addition, domestic liquidity will sustain in India with SIP flows expected to remain steady.
The general election scheduled next year clouds the economic and market outlook. However, the uncertainty will be over by H1CY19. Analysis of market performance around past general elections shows that returns in the 6-month period both before and after elections have been mostly positive. Also, FPI flows have generally picked up after election uncertainty is over. Clearly, while elections can lead to short-term blips, the market reverts to fundamentals shortly thereafter, and market performance will be driven mainly by the strength of the economy.
Mahesh Patil is co-chief investment officer at Aditya Birla Sun Life AMC