Why FY19 is likely to be a volatile year for Indian equities

It won’t be an easy ride for the markets, reckon experts, considering the multiple state elections in 2018 and general elections next year. 

Indian equities were on a roll for the most of 2017-18 aided by strong domestic liquidity and favourable macroeconomic conditions. In fact, the ride till January this year was so smooth that the market did not witness a single correction in excess of 5 per cent.

The rally, however, has been derailed since February, and experts believe 2018-19 will be a volatile year. 

The sharp rise in global bond yields was a key factor that contributed to the recent volatility.

Yields on India’s 10-year government securities also touched a four-year high in February on fears of high domestic inflation and aggressive rate hikes by the US Federal Reserve.

Likewise, widening of the fiscal deficit targets raised concerns of a reversal in the policy stance by the Reserve Bank of India. This, coupled with the scam involving Punjab National Bank, weighed on banking shares that have significant weight in key stock indices. The reintroduction of the tax on long-term capital gains in the Budget and higher taxes on mutual fund investors also dampened sentiment.

Indian equities corrected 5 per cent in February and another 3.5 per cent in March, eating into the gains clocked during the first 10 months. Thus, the S&P BSE Sensex ended with gains of 11.3 per cent and the 50-share Nifty was up 10.2 per cent in 2017-18. 

On the brighter side, earnings growth, which was a drag in the first two quarters due to demonetisation and goods and services tax rollout, was promising in quarter ending December 2017. Experts believe that an economic recovery is on its way and that should help corporate earnings grow in double digits in FY19. 

“The whole of last year we have been waiting for the earnings growth to pick up; that finally seems to be happening. But, exports growth still hasn’t picked up and interest rates are set to go north, factors that may impact sentiment,” said UR Bhat, managing director, Dalton Capital Advisors (India). 

According to Deutsche Bank, India has been witnessing a strong divergence between fundamental sectoral trends and investor sentiment since mid-2014, which manifested in a breakaway between equity market performance and corporate earnings growth. The bank believes this trend is set to reverse.

“While sentiment has soured on the back of both rising oil prices, an inflation led bond market sell-off and domestic factors such as the Nirav Modi fraud and fears of slowing loan growth… ground indicators across industry have shown a sharp improvement,” said Abhay Laijawala, head of India research at Deutsche Bank.

As per Deutsche Bank, loan growth of banks has more than doubled to 11 per cent year-on-year from a low of 4.4 per cent in February, commercial vehicle sales are rising by 25 per cent year-on-year and steel industry’s capacity utilisation has risen to 84 per cent, leading steel prices to rise to a nine-year high.

Still, there are a number of factors that will add to the uncertainty in the coming fiscal.

“It’s unclear if the ruling party will come to power next year. Global crude oil prices have been inching up and there is concern that the US Fed may raise rates aggressively. Add to that the bad loan mess and recent fraud at one of the public sector banks. All these factors would not have counted for much had the valuations not been so rich. As things stand, investors need to be a bit wary,” said Raamdeo Agrawal, managing director, Motilal Oswal Financial Services.  

Brokerage Nomura believes that higher US rates, dollar appreciation and G3 central bank balance-sheet reduction could accelerate capital outflows, raise domestic interest rates and trigger rupee depreciation -- creating a vicious cycle of external funding pressures and balance-sheet stress. 

Most experts believe that 2018-19 will be more volatile.

Sanjay Mookim, India Equity Strategist, Bank of America Merrill Lynch says global markets are going to be volatile, and this will show on Indian markets too.

“For many years, central banks have been buying a lot of assets and in the middle of this year (2018) we expect the asset purchase programs to slow down or turn negative. Higher interest rates in the US can increase pressure on equities. Our December 2018 forecast for Sensex is 32,000,” adds Mookim. 

At Rs 192 billion, net buying of equities by foreign portfolio investors was subdued. Domestic institutional investors, including mutual funds and insurance companies, however have stepped up purchases in the past three years; in 2017-18, DIIs bought shares worth Rs 1.03 trillion. 

However, even with domestic liquidity support, it won’t be an easy ride for the markets, reckon experts, considering the multiple state elections in 2018 and general elections next year.

Nomura says that the current account deficit is likely to increase to two per cent of GDP in 2018, up from 1.7 per cent in 2017.

Widespread agrarian distress could push the government to announce populist policies, fuelling inflation, fiscal slippage and a further widening of the trade deficit.

Third, non-performing assets could rise to 11.1 per cent of total advances by the third quarter of CY2018 from 10.2 per cent a year ago.

Photograph: Arko Datta/Reuters.