INSUBCONTINENT EXCLUSIVE:
gone by has been and think through our strategy for the year ahead before making the New Year resolutions.
Roller Coaster YearCalendar 2018
was a roller-coaster year
It started on note of high optimism and enthusiasm on the back of strong returns from Indian and global equities in 2017, but it ended on a
note of cautious optimism blended with some scepticism
Thus, there was a diametric swing in moods and opinions, with exuberance at the start of the year giving way to circumspection
Similar choppiness prevailed beyond equities too.
The 10-year Indian government bond traded at 7.34 per cent at the start of the year and
yields spiked to 8.18 per cent before ending the ear at 7.27 per cent.
Likewise, oil prices (WTI crude) traded at $60.40 at the start of the
year and spiked to $76.39 midway through only to fall to $45.49 by yearend.
Nifty50 has given just 2.4 per cent returns during 2018 amid
significant volatility (Chart 3)
Thus, while it may look like that not much has changed during the year, the underlying macro-economic trends indicate that significant
shifts have taken place through the year.
Structural ReformsOver the past few years, India has executed significant structural reforms,
including GST, Insolvency Bankruptcy Code, Direct Benefit Transfer, Real Estate Regulation Authority (RERA) and a few more
reforms, they tend to be disruptive in the first few years and have an economic and political cost in the short term, but their long-term
benefits tend to surprise on the upside and are enduring.
We firmly believe most of the reforms are game changers and the eerie consensus is
grossly underestimating the potential benefits of these reforms.
Midcaps SmallcapsThe year 2018 saw significant correction in midcap and
smallcap segments, as they retraced their strong gains of 2017
In 2018, the BSE Midcap Index is down 14.6 per cent and the BSE Smallcap Index 24.7 per cent
The rally in the midcap and small segments in 2017 was driven by a surge in liquidity and high retail participation, where a lot of weak
hands had bought into a lot of these stocks and they seem to have capitulated at the first sign of pullback in stock prices
Valuations of midcap and smallcap stocks were rich and unreasonable at the start of 2018, with the BSE midcap index trading at 31.40 P/E (12
month forward) and at a 72 per cent premium to the largecaps
It was apparent that such premium to largecaps was unsustainable and a mean reversion was imminent, which finally happened in 2018
While valuations in midcap and smallcaps have moderated significantly, they are still not cheap at aggregate levels
Having said that, we do find pockets of good value in these segments.
NBFCThe NBFC sector was in the middle of a perfect storm towards the
latter part of the year, as a confluence of events created an upheaval in the sector and triggered sharp selloff in stocks
This was something waiting to happen, as the sector had been growing its loan book at an exponential rate over the past five years and many
players were using excessive short-term funding to fund
long-term growth and show higher profits
As usual, the stock market was generous in rewarding the sector, with some companies getting market-cap exceeding their loan books and new
NBFCs mushrooming every day.
The froth was evident, companies were growing aggressively, overlooking the risks and it had an eerie
resemblance to past bubbles
We have seen significant proliferation in the sector with NBFC being perceived as the hottest sector and every businessmen and group of
professionals racing to start a new NBFC (reminds us of what happened to power telecoms Sector in 2007)
While NBFCs (shadow banks) have an important role to play in any ecosystem, we believe there has been a fundamental shift in the sector and
it will undergo consolidation.
We continue to remain on the lookout for good companies with healthy growth outlook at reasonable valuations
in this space.
ConsumerThe consumer sector has done exceedingly well during the past decade (Fy08-18) and rightly so as it was on the right
But stock returns within the sector have been far in excess of underlying earnings growth leading to sharp multiple expansions
We reached a stage in the cycle, where while growth is moderating in the sector, yet valuations multiples have kept expanding due to strong
We continue to believe that valuations in the consumer sector are mispricing future growth expectations and are likely to moderate over the
Something similar had happened in the past cycle when the stock returns in the sector had trailed earnings growth and a likely repeat of the
There were multiple reasons for this below-potential growth over the past five years, including twin balance sheets issues, broken
investment cycle and disruptions due to structural reforms, to name a few
But, the Indian economy has reached an important inflection point in this cycle
The macro-economic fundamentals are stable now and they inspire confidence
We are at the peak of the NPA cycle in the banking system and going forward lower provisioning should create fresh lending capacity in the
investment cycle is making a gradual comeback
Capacity utilisation on aggregate basis is improving significantly and should reach the threshold of 80 per cent in next few years
Public investments are accelerating at both the central and state government levels and we are seeing healthy recovery in industrial and
Order books of leading companies in capital goods industry have been growing in high teens in last four quarters, indicating a revival in
The resolution of stress assets is providing fillip to brownfield investments and this should accelerate over the next few years
Business and consumer confidence are on an upswing
recovery in Indian economy in 2HFY20, and the much elusive earnings growth should come back strongly
We are near the end of the earnings recession that corporate India has witnessed over the past five years
Also, we have witnessed significant moderation in valuations with Nifty now trading at about 18 times FY20 earnings, which is much more
reasonable than its valuations at the beginning of last year.
Thus, the bar for outperformance of equities as an asset class is much lower
going into the next year with tailwind of earnings growth
One should use the volatility in the early part of the year to build the portfolio for the next growth cycle of India, which is around the
We continue to remain focused on executing our investment strategy across funds and look forward to the New Year with a sense of optimism
and enthusiasm.
Looking ForwardDespite scepticism on the Street, we look forward to 2019 with a fair bit of optimism
I believe Calendar 2019 is going to be a year to two halves
Global risks have come to the fore with apprehensions about impact of trade war, US recession in 2019 and rate hikes by global central banks
impacting business and consumer confidence.
While Indian market would get impacted in the short term, due to any selloff in global equities,
we firmly believe that India is in a much better situation to deal with any of the global risks than any other economy in the world and the
significantly over the past five years and after gap of almost 10 years, those are inspiring confidence in the top-down India macro story
economies (in 2013) to a stable economy with strong fundamentals.
(Pankaj Murarka is Founder of Renaissance Investment Managers
