We are in the midst of one of two critical reforms — Demonetisation or Remonetisation. Another significant one is the GST. Both of them have marked long-term implications for the economy and markets.
The market is estimating a 150-200 bps hit on GDP for H2 FY17. This will be smaller, going into FY18. At the Nifty 50 level, we expect the earnings growth cut to be in the range of 150-200 bps for FY17. It should be highlighted that 55 per cent of Nifty companies in IT, pharma, utilities and oil & gas are not affected by demonetisation. Among the rest, the slowdown seems to be limited and short-lived for sectors like auto, FMCG, banks, media and engineering. For some sectors like paints and cement, the slowdown in earnings could be a little prolonged due to slowdown in the real estate sector. For the next 2-3 quarters, earnings could see huge volatility. However, once the transitory phase of demonetisation gets over and we tide over the initial hiccups of GST, the growth for FY18 would look healthy.
Overall, the downside from current levels might be limited. It would be a good strategy for investors to stagger investments over the next few months to take advantage of the earnings uptick in FY18. Large-cap stocks and funds are better vehicles to participate as the impact of demonetisation is limited, the bounce-back faster and benefit from GST significant for these companies.
How will Trump’s victory and the US Fed rate hikes impact fund flows into the equity market?
There is widespread expectation that the new US President may increase fiscal spending and cut corporate taxes, helping economic growth. Hence, inflationary expectations have gone up. The Fed thus hiked interest rate by 25 bps in the December 2016 policy and it projects to increase rates by 75 bps in 2017. This has led to strengthening of the USD and outflows from emerging markets (EMs) including India. But it is to be seen if reality is any different from expectations. If there is disappointment, money could flow back to EMs including India. If the USD strengthens further, IT & Pharma would benefit from rupee depreciation.
Will investors be better off sticking to large-caps in 2017?
On the valuation front, the mid and small-cap stocks are trading at a premium compared to large-caps. As the effect of demonetisation and GST is felt by the domestic economy and the mid/small cap segment is exposed to it, earnings could see a hit and the premium valuation which they command may have to come down. The large-cap companies have enough levers to cushion the blow and in fact there are many large-cap stocks that may not be impacted. Hence, exposure to large-caps is recommended until the uncertainties clear out.
What are your earnings growth estimates for the Sensex?
The earnings were on the right trajectory for good growth in H2 FY17 before demonetisation happened. However, due to this event there is a setback in the short term (2-3 quarters).The large cap index should see mid-high teen growth in one and two years time frame as consumption revives and government expenditure persists. Also, if world economy picks up led by US, we should be able to see growth in exports as well.
What is your view on the valuation of large-cap stocks?
The valuation of large-caps on a trailing P/E (price-to-earnings) basis is just above fair. As we leave behind 4-5 years of weak growth and enter into a stronger growth period, the valuation would start looking attractive. Even on metrics like P/B (price-to-book) and Marketcap/GDP ratio, they are trading at fair value.
Private banks, consumer discretionary, IT, pharma and oil & gas look attractive. The sectors to avoid would be cement and telecom.
(The article first appeared in BusinessLine's Portfolio section.)