Shallow recession in the developed economies could be a blessing for India

At a time when most world markets have remained under pressure, Indian equity markets this year set life-time highs. On December 01, the S&P BSE Sensex index rose 0.29% to hit a record high of 63,583. Similarly, the broader NSE Nifty marked a new all-time high of 18,887.

YTD, the Nifty and Sensex have risen nearly 4.48% and 4.42%, respectively. The rally in domestic indices so far this year has amply proven that it is far ahead of its global counterparts.

The robust performance of the Indian markets was made possible due to the low correlation to the global economy when compared to other emerging markets, a robust economic scenario, and a recovery in the investment cycle, says TATA Mutual Fund in its equity outlook report.

Going forward, the report says, a shallow recession in the developed economies could be a blessing for India as crude and other commodity prices will come down. However, in case of deep recession, the risk of a liquidity event and risk-off environment will impact Indian markets too and challenge the valuation premiums, the report added.

Profitability trends have marginally Improved

India markets have outperformed given the expectation of strong earnings momentum this quarter. "Corporate earnings downgrade risk has materially decreased, according to the report, and the possibility of slight upgrades has increased."

Banks and capital goods lead the positive earning upgrade cycle, while the softening of commodity prices and margin support in IT services are incrementally positive.

Even sectors with topline risk including IT and FMCG will have their margins supported by either lower input costs or easing wage pressures, the report says.

However, the biggest risks for the markets come from volatility in global commodities. A rise in crude prices could lead to a reduction in India’s valuation premium, according to the report, which raised concern.

Growth drivers for India

The report says, India's long-term earnings drivers include an improvement in the investment cycle and an improvement in the credit cycle, as well as a pickup in real estate sector.

In addition, tailwinds for the Indian manufacturing and industrial sectors are propelling India's growth. If commodity prices come down, it will drive the growth even further, the report added.

Balanced portfolio strategy to capture the economic cycle

To build a well-balanced portfolio, investors should increase their exposure to mid- and small-sized banks, which will perform well in the future due to higher credit growth and lower NPAs.

The industrial/capital goods sector should also be considered, as recovery in the investment cycle, led by healthy cash flows in the corporate sector, and the government's counter-cyclical fiscal policy are the main driving factors for the sector, according to the report. 

The report maintained an underweight rating on the IT sector due to global uncertainty. With an increasing number of companies seeking digital solutions, IT spending has gone up structurally.

Sectoral Performance

In terms of sectoral performance, the Nifty PSU bank index outperformed all NSE indices in the last year, rising 65.19%, followed by the Nifty FMCG, Nifty Bank, Nifty Metal, and Nifty Auto, which rose 21.70%, 19.71%, 18.24%, and 17.11%, respectively.

Equity Inflows

Foreign institutional investors have largely sold Indian equities this year, but there has been some reversal in recent months. Financial services and telecom are the sectors primarily held by FIIs and could benefit from this slowdown of outflows.

DIIs have joined the FII selling frenzy, with their holdings of Indian equities reaching an all-time high of 14%.

Mutual funds were buyers in November with inflows of $165 million, and insurance funds were net sellers in the month with outflows of $439 million.

Crude oil prices have come off sharply

Oil prices declined sharply by 7.2% over the month of November, following a rise of nearly 8.3% in October. Crude oil prices remain critical for India, as they directly affect the country's macroeconomic parameters much more than those of other emerging markets, the report pointed out. 

“It is no longer about the demand and supply of crude oil. It is more about what's going to happen geopolitically, how OPEC is going to react to it, and if will they try and protect the prices." Says TATA MF. 

Meanwhile, the Indian Rupee has depreciated by 9% against the dollar, and other advanced countries like the U.K., Euro, and Japanese currencies have fallen by 12% to 20% against the dollar.

The Indian currency has depreciated against the dollar but appreciated against the Euro, the British pound by 3% and against the yen by 8% in the current financial year.

Expensive Valuations 

The report stated that valuations have come off with earnings growing faster than the market capitalization, but they are still high on an absolute basis and also higher than the long-term average.

“Nifty one year forward PE is currently  at19.0-19.5x. It had declined to 17x a few months back which along with cyclical recovery attracted incremental inflows. Nifty50 PER is at an 80–90% premium to other emerging markets; hence, sustained earnings performance becomes critical to sustain valuations.”

“Over the last 12 months, the MSCI India index has outperformed with a rally of 8% compared to the MSCI EM index, which has fallen 20%. Over the last 10 years, it has outperformed the MSCI EM index by 187%,” the report says. 

In P/E terms, the MSCI India index is trading at a 139% premium to the MSCI EM index, above its historical average of 67%.

Disclaimer: The views and recommendations made above are those of individual analysts or broking companies, and not of MintGenie.