Will 2014 be any better for investors?
(Any opinions expressed here are those of the author and not of Thomson Reuters)
High inflation, low GDP growth and a sharp depreciation in the rupee led to subdued returns of 6.8 percent for the Nifty in 2013.
The core sectors — steel, cement, industrials, energy, infrastructure and capital goods — continued their poor performance and hence valuations shrunk, while consumer staples, IT, pharma and private sector financials bucked the trend. But the polarisation towards a few sectors underscores growing risk aversion.
But will the 2014 be better for investors in India? Our best bet is a significant improvement in equity valuations over the next six months if global recovery continues and crucial policy decisions are taken. Any participation by the core sectors in earnings growth would help expand the multiples, leading to improvement in valuations.
As things stand, we believe the Indian economy is at the cusp of a turnaround. GDP growth, which slipped to 4.6% in the first half of the current fiscal, can improve to 5 percent. Equity valuations mirror this expectation. With the Nifty in the range of 6,100–6,300, the market is discounting next fiscal’s expected earnings nearly 13 times. That’s neither too cheap nor expensive and suggests expectations of a broader recovery.
In the worst-case scenario, there would be little accretion in the Nifty, assuming flat earnings in core sectors, formation of a weak government after the general elections and fresh global risks.
The trajectory the local bourses will take will be clearer around the middle of this year. In the interim, I expect news-driven volatility in indices.
Going forward, the momentum of recovery will depend on three critical factors:
- Improvement in the earnings of core sectors
- Policy impetus (or its absence) after the general elections
- Improvement in the global economy
While earnings in the second quarter of the current fiscal were marginally better than expected, with revenues and operating profit growth of 10 percent each (for 1,145 companies representing the manufacturing and services sectors but excluding financials and oil companies). These were driven by export-linked sectors such as IT and pharmaceuticals along with media and telecom.
Hope floats, nevertheless. Revenue growth should recover from low double digits of this fiscal, supported by low base after two years of sluggishness. But any upturn will be mild and revenue growth in the next fiscal will remain below the historical average of about 18 percent.
We believe IT, pharmaceuticals and readymade garments will do well on improved competitiveness due to currency depreciation and better global growth. Sectors with exposure to rural income such as agrochemicals, two-wheelers and tractors should also post good earnings growth.
On the other hand, issues of the core sectors such as cement, steel and construction will take longer to resolve.
In the backdrop, the results of the general elections in May will be critical. The new government faces the task of lifting growth and controlling inflation, which will mean de-bottlenecking of core sectors as the first step. Any policy action will bear fruit only after two to four quarters.
Global recovery remains another cog in our analysis. The Federal Reserve is expecting a gradual recovery in the U.S. economy in 2014. But apprehensions that inflation will be sticky below the targeted rate of 2 percent persist and many do not expect any hike in the federal funds rate until 2015.
In such a scenario, investors are advised to stick to fundamentals, shun beta stocks and carefully examine the sustainability of earnings before making any investment decision.