In Samvat 2071, the hopes of a fast recovery in economy and corporate earnings have fallen short of expectations. Critical reforms are stuck in a political logjam and the pace of recovery in economy is anaemic despite the majority mandate in the general election at the centre and the favourable impact of the softening of commodity prices. Having said this, the government has done its bit in terms of pushing policy changes that do not require legislative nod, like coal mine auctions, restructuring of the power distribution companies and deregulation of prices of petroleum products. However, the same is not enough to stimulate the desired pace of economic recovery; perhaps the expectations were running ahead of reality.
Earnings-mixed trend, no clear signals yet: In terms of earnings, the Q2FY2016 results season largely seems to be on the expected lines on an aggregate basis but with its share of surprises, both positive and negative, in individual stocks. On the revenue front, a weak demand and pass-through of soft raw material prices kept the revenue growth weak but the performance at the operating level was much better due to an expansion in the margins. A lower input cost and operating leverage aided some of the companies to show a better than expected growth in the earnings. Hopes are pinned on the H2FY2016 performance since the consensus is still building in a 10-12% growth in the aggregate earnings of the Sensex companies in FY2016 despite a rather flattish earnings performance in H1FY2016. The recovery in corporate earnings is expected to be driven by a gradual improvement in consumer demand (driven by moderating inflation and transmission of low interest rates) along with a low base effect (H2 of FY2015 was exceptionally weak).
Globally, rate hike uncertainty close to its end: The recent economic data from the USA provides enough reasons for the US Federal Reserve (Fed) to finally go ahead with the unwinding of its zero interest rate policy. Though there could be some volatility in the run-up to the event, we believe that the market has had enough time to adjust to the impending scenario. The market’s reaction to the final unfolding of the withdrawal of quantitative easing (QE) in the USA or the ruling party’s drubbing in Delhi and Bihar clearly proves the point. Moreover, the monetary policy environment remains extremely accommodative in most developed regions like Europe, Japan and now China.
Valuations-benchmark indices slip to the lower end of their multi-month trading band: In the past few months, the market has been adjusting to a slower than expected pace of economic recovery and weak corporate earnings by consolidating in a broad trading range. Recent unfavourable events have pushed it to the lower end of the multi-month range (and comfortable valuation of 15x one-year forward earnings) where the risk-reward ratio has turned favourable for investors.
Samvat 2072: low on expectations; high on delivery: Unlike Samvat 2071, the expectations are pretty moderate for Samvat 2072 though the macro environment is much better now. The twin deficits (current account deficit [CAD] and fiscal deficit) and inflation are under control. The impact of policy rate cuts of 125 basis points (BPS) by the Reserve Bank of India (RBI) would begin to reflect on demand and corporate earnings (the base rate of banks is down by 60-80BPS). Moreover, the possible passage of some critical pending bills in the forthcoming winter session of the Parliament could provide the necessary boost to sentiment. Consequently, we retain our positive stance on equities.
Investment themes: In terms of strategy, we believe that it would be prudent to turn more selective in defensive sectors, information technology (IT) services and pharmaceuticals (pharma). The best performing pockets could be financials and urban consumption companies. Lastly, it is likely that mid-caps and bottom-up stories may outperform the Sensex and the Nifty in this year also.