Stability breeds instability – we in the markets often tend to forget this famous dictum of Hyman Minsky, only to be reminded of the same with a sudden and rude shock.
As we closed 2017, complacency was setting in. Comfort around global growth was taken as a given and investors underpriced the potential risks associated with twin tightening in the US: rate increases and unwinding of balance sheet. VIX, a proxy for markets’ risk aversion, hit historical lows in the second half of 2017.
What followed was a huge shake-up. Markets sold off significantly and sharply: first in EMs (bonds, equities and currencies) and subsequently in the US. S&P 500, which looked invincible at one point, sold off precipitously 15–20% in two months) and high-yield spreads in the US widened from unusually low levels.
In India, September turned out to be disastrous due to the IL&FS default and liquidity squeeze for all NBFCs, spike in oil prices and INR depreciation. All these happened in a short span of time and all-time high leveraged position[s?] in the market led to panic selling, especially in the small & mid cap segment.
Nonetheless, Indian markets returned close to 6% and outperformed the MSCI EM Index by almost double in dollar terms – which is impressive given what’s happening around the globe. Things are gradually stabilizing as oil prices reverse the course and local liquidity gets better. However, the situation is not back to normal yet.
2019 : Year of global slowdown, liquidity pressure and TREADING CAUTION
Current global backdrop: As we progress into 2019, we should keep in mind global growth is surely showing signs of deceleration in a synchronized manner. The sword of global trade tensions is still hanging. While the Fed seems to be getting close to the normal rate, with one or two more rate hikes left in this cycle, balance sheet unwinding continues. Meanwhile, the ECB has stopped injecting liquidity. Deceleration in global growth coupled with a liquidity squeeze cannot deliver good equities’ return. The case for Commodities is likely to be similar. Moreover, a large part of the debt added post-2008 (Global Financial Crisis) is more than its needed share of incremental GDP, representing unproductive investments. The debt bubble in China too continues to be a threat.
Indian backdrop: A mild slowdown in global growth is positive for India’s fundamentals as it keeps commodity prices in check. But India still needs to address some of the key issues. There is an urgent need to kick-start the credit cycle and accelerate the capex cycle, which might be difficult amid the current domestic banking set-up.
The general election in 2019 is more likely to divert fiscal resources back to the agriculture sector and rural economy, which might boost consumption. The currently fragile and heated political environment will keep policy fairly unpredictable and make it hard for government to take necessary steps.
What stands out though for India is its low levels of both domestic and international leverage, which insulate it from global shocks to a great extent. India is surely better placed from global shocks on a comparative basis, and this provides downside protection in an otherwise global fragile environment. India will again outperform most developed and emerging markets in 2019.
One needs to plan and invest in 2019 keeping in mind all or at least some these realities. Investment decisions should be anchored around the following themes:
Earnings growth: Better, but broad-based revival still distant
The earnings cycle has been disappointing for a while now. 2019 is unlikely to be much different. Expect earnings traction to be in select pockets, rather than a broad-based revival. Overall, in this tough global landscape, if we achieve mid-teens’ earnings growth, it will be commendable. What needs monitoring is the government’s ability to keep up spending in the economy until the private sector is fully back on its feet. In this regard, developments pertaining to fiscal consolidation targets, and one-time large transfers from the RBI to the government for PSU bank recapitalization etc are crucial to monitor. I do feel that some fiscal relaxation is well-advised at this stage.
Credit and liquidity flow: The key monitorable
An important fallout from the liquidity crisis in the second half of 2018 will be on lending to the real economy. In the last few years, NBFCs have been at the forefront of lending and the retail sector or households (LAP, mortgages, autos, unsecured, etc) have been the key borrowers (the corporate sector was largely deleveraging). While the situation has begun to normalize gradually, the liquidity squeeze has clearly taken a toll on lenders’ risk appetite. Thus, NBFCs’ lending growth may not return to 25%-plus anytime soon. And PSU banks are still far from the normal credit cycle. In such a scenario, select private sector banks cannot fully meet the growing demand for credit. In this regard, one should watch out for the RBI’s moves under the new Governor. Timely and meaningful steps to ease liquidity can certainly limit the damage. It is encouraging to note that the RBI has already stepped up OMOs.
Monetary policy: Prepare for rate cycle reversal
We should be open to the possibility of reversal in the global rate cycle in 2019. The global economy is slowing down conspicuously with interest-sensitive segments such as autos and real estate slowing almost everywhere.
Furthermore, with a fall in equity prices and widening of bond spreads at the global level means that monetary conditions are tightening further. Finally commodity prices have begun to come off, starting with crude oil prices. Thus, there is a good possibility that the rate cycle reverses. It is therefore quite possible that we might see one or two rate cuts by the RBI during the year, which should be good for the Indian economy and markets.
Domestic flows: Standing up to the test of time
As mentioned earlier, the strength of the domestic retail savings flowing into markets is particularly encouraging. Domestic flows have held up despite persistent FII outflows, India’s deteriorating India’s macros as crude oil jumped and the INR fell, and persistent earnings disappointment. In that sense, one could argue that the ramp-up in domestic flows to financial markets is not just a short-term blip, but is perhaps a reflection of a more structural trend that is underway.
This is not to suggest that Indian markets are completely de-linked from the rest of world, but it does provide cushion during periods of sudden reversal of global capital flows.
Crude oil fall-off: India is an oil trade
That India benefits from lower oil price is stating the obvious. To that extent, oil cooling off from USD80/barrel levels to now below USD55/barrel is a boon for India. If the crude remains below or around this range, it will surely give India resources to deal with some of the domestic problems and a widening CAD due to electronics consumption.
Politics: To take centre stage in first half of 2019
The general election in May 2019 will keep markets busy in the first half. It is going to be a hard-fought battle between the BJP and the Congress, and the outcome is uncertain. While markets would like to see continuity of the NDA government, it must be emphasised that India has seen a fair bit of policy continuity regardless of the party in power. One must say that many key reforms (GST, RERA, IBC, DBT, etc) are irreversible irrespective of who forms the government in Delhi in 2019. A fractured third-front kind of government will surely have negative impact, and markets may not do well in that case.
In a nutshell, it may not be a smooth ride in 2019. There would be volatility in the market, although at this stage it appears that the second half is likely to be far more positive and constructive.
• Leverage should be avoided, and one should patiently wait to take advantage of market corrections to buy companies and sectors with structural growth.
• Bond markets could be the star performer in 2019—specially adjusted for risk.
• Real estate will continue to struggle until liquidity and rate cycle changes, but would bottom out this year as it is getting more structured and organised.
• Commodities are unlikely to perform given the current set-up.
• Equities will have a moderate year, but this year is more likely to form a base for the years ahead. The second half will be far more constructive than the first half.
• In summation, 2019 will be great year to pick stocks amid volatility.
Sectors/themes I think will do well:
BFSI – Private sector banks, unleveraged structural plays like GI, AMC and other services companies.
Industrials – Capex cycle is slowly picking up and public capex can get further boost due to election.
Manufacturing-led plays are becoming more and more attractive due to China factor and trade war.
Unorganised to organised theme, which cuts across many sectors/segments.
Lastly, Consumption plays, especially rural-focused non-discretionary, might do better.
The best time to buy market is when no one is keen to buy, leverage in low in the market, uncertainties are galore, which is the current set-up. The only caveat is that one should be prepared to sustain and be in the game if markets still disappoint you.5