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STRUCTURAL GROWTH DRIVERS REVISITED

Aug 20, 2018

Equities

Structural reforms undertaken by the Modi regime are beginning to bear fruit. We’ve highlighted the benefits of structural reforms and how growth tends to come through at a lag. (See “Key Drivers for the Next Leg Up”, Oct 16, 2017).

C.O.R.E Growth Drivers

C.O.R.E is our acronym for easy reference to India’s key drivers – C for Credit, and Connectivity, O for Online, R for Reforms and E for Employment. These are the key factors driving India’s uptick in growth. Connectivity, whether via highways, airways or waterways, is directly related to growth and leads to faster movement of goods, higher productivity and provides wider access to resources and labor. C is also for credit, which is expanding rapidly in the services and retail sector.

Online drives information connectivity, providing access to opportunity, information and knowledge, which again is closely correlated to growth. Reforms – Aadhaar, RERA, GST and demonetization – have fundamentally changed the infrastructure platform for the transactional economy. The benefits of these reforms have come at a lag, as we suspected they would, as we finally see signs of a broader based pick-up in growth. Finally, Employment drives the size of the labor force.

Strong Show on Earnings

We report earnings for the Nifty 50 and CNX 500 ex public sector banks and also exclude the very large loss from Idea Cellular. With 471 companies reporting, the adjusted numbers are stellar. Nifty 50 sales are up 19.7% and profits are up 18.0%, and CNX 500 company sales are up 15.4% and profits are up 20.9%. With crude oil declining below $72, from 10% higher levels last quarter, we expect profit margins to improve further in the current quarter. Somewhat surprisingly, the broader market demonstrated better operating leverage, delivering lower top line growth but higher profit growth. We’d have expected larger companies to do better given experienced management, access to lower cost capital etc.

Sales for the Nifty 50 ex SBI, are Up 19.7% and Profits are up 18.0%…

Sales for the Nifty 50 ex SBI, are Up 19.7% and Profits are up 18.0

While Sales for the CNX 500 are Up 15.4% and Profits Up 20.9%…

While Sales for the CNX 500 are Up 15.4% and Profits Up

While Sales for the CNX 500 are Up 15.4% and Profits Up

While Sales for the CNX 500 are Up 15.4% and Profits Up

Domestic Economy Remains Healthy

Domestic PMI data is moving higher and in the best shape it’s been since the demonetization quarter. PMI Services is at 54.2, and the Composite at 54.1, are the highest readings since Oct ’16, right before demonetization. It’s taken the economy almost two years to regain the momentum.

IIP is back at 7.0%, with sub components Mining, +6.6%, Electricity +8.5%, Manufacturing 6.9%, Consumer Durables +13.1%, Basic Goods +9.3% and Capital Goods +9.6% showing momentum to the upside.

Inflation data has moved back within tolerable ranges for the RBI. Food inflation is under control.

Finally, automobile, light and medium heavy commercial vehicles sales are surging. Light and MHCV sales are at multi year highs. 3 wheeler sales are growing 51%. Clearly, the rural sector is recovering well, as government investments have accelerated in recent months. We also looked at three month rolling average sales and YTD versus prior year sales. In both cases, the sales data iron out the seasonality and one off impacts of GST last year, and look robust.

However, Trade Wars, A Widening CAD and a Weakening Rupee Are Risks

India’s made significant progress since the days of the Fragile Five. Recent news about the CAD worsening to a 4 year highs is accurate, but somewhat alarmist. First, the fiscal deficit of 3.5% today is the lowest it has been in the past 10 years, and only once has it been meaningfully lower in the past 20 years. The current account deficit ballooned to 4.81% in 2013. It’s at 1.8% today. The fiscal deficit was 4.8% in 2013. It’s 3.5% today. We’ve come a long way from those days.

However, the vicious circle of FI investors incurring losses, leading to further outflows leading to a depreciating currency, holds the risk of worsening the CAD. One relief is that oil prices have come down in the last couple of weeks.

There are benefits too. A weaker Rupee is good for exports, as it will help sectors such as IT, Pharma and other export industry. It will also incent developed world manufacturers to set up industry in India.

CAD Rising But Nowhere Near Fragile Five Days

Outlook

Equities

Impressive Performance Despite Challenging Conditions

What’s becoming reasonably clear is that the government would like to see a strengthening economy heading into the elections. The benign inflation data has helped address the overhang of additional rate hikes. Meanwhile, companies have delivered earnings growth in what can be argued were quite adverse circumstances with EM stress, trade war protectionism, volatile and rising crude oil prices. With robust earnings expectations for the second quarter, the market is likely to continue to be bought on weakness.

Low MSCI Exposure a Boon

We have noted for some while, India’s limited exposure of barely 1% in the global MSCI index and approximately 8-9% in the emerging markets MSCI index. This is turning out to be a boon as we enter a new world of central bank liquidity drainage. Estimates suggest $100 billion will be removed from global equity this year. Given India’s limited exposure in MSCI, that’s a relief, and could be one reason India has continued to outperform it’s emerging market peers.

Fixed Income

We Remain Wary of Global Risks

With declining headline and food inflation, and declining crude, a case can be made that g-sec rates have peaked. However, a number of global risks remain and we’re not prepared to take that call.

FI Debt Investors Remain Sellers

With the Chinese yuan under pressure, and close to falling below 7.00 per dollar for the first time in over a decade, there was some respite last week as talks planned for later this month between lower-level officials from Beijing and Washington offered a glimmer of hope that the two superpowers may work towards a solution to their escalating trade conflict.

The RBI may have limited choice but to let the currency depreciate in line with other EM currencies. Should this occur, it will adversely impact the domestic materials sectors and import inflation, while raising the cost of servicing debt, leading to upward pressure on interest rates.

The government has embarked on an aggressive spending spree, and the worsening CAD remains a concern, that could create pressure on the currency. With an improving economy, the risk remains that inflation could re-surface and this isn’t the stage in the business cycle where one would expect a meaningful decline in interest rates.

We favor corporate bond funds and credit risk funds, ideally with proven managers. For conservative investors, we suggest short duration bond funds.

Technical Outlook

The Nifty closed week on positive note at 11471 levels up by 0.75% for the day and on weekly basis ended higher by 0.36% after touching low of 11340 level. For the week ending 10th August index had formed Doji like candlestick pattern on weekly chart after touching the upper end rising trading channel connecting lows of 9958-10604 and highs of 10929-10495. Since then index has seen some profit booking and traded sideways last week. On daily time frame Nifty has managed to hold above the rising support trend line connecting lows of 10558-10946 and seen a bounce back. Price and Relative strength index on daily chart are showing positive reversal; i.e. RSI is making lower low while Nifty is seeing higher high formation which is generally seen in rising market. Thus, crossing above 11495 levels expect the uptrend to continue towards 11580 and then 11700 levels. On downside market has immediate support at 11340 levels. Breaking below this level market is likely to test important support level of 11200-11170 which is the previous all-time high and breakout level.

In Nifty options, maximum open interest in Puts stands strike price 11000 followed significant build up at 11400, 11300 and 11200 indicating as good supports at lower levels; while in Calls maximum build up is seen at 11500 and 11600 indicating as immediate hurdle for the market. In Friday’s session good amount of Put writing was witnessed in 11500 and 11400 while Call unwinding in 11500 suggests market is likely to head higher. India VIX closed lower by 3.5% at 13.16 levels but it is trading in a range and crossing above 14 levels could spoil the rally.

Nifty Daily chart

Nifty Daily chart

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