As we come to the end of the year 2019, one thing can be said for sure. It was an intriguing year with several ups and downs and an eventual end to the year near all time highs. It has also been the most unloved all time high with most people holding small and mid cap stocks still not feeling good about the rally. As per my expectations at the end of last year the overall market move was in line with what I thought, however the continued underperformance of the broader markets, mainly due to the extreme slowdown in the economy caught me by surprise.
There were a few expectations at the end of last year i.e. Central bank easing will restart and that will aid equities, markets will pull back substantially after the sell off at the end of 2018,Emerging Markets could start doing better than developed market equities as global central banks ease again and that Indian Economy will see a pick up post elections as a strong mandate will make the government push growth harder.
The first two expectations came true, however Developed Markets still outperformed and the Indian Economy continued to slow driven by both a lack of focus on the economy by the government as well risk averseness in lending in the financial sector. Several NBFC’s like IL&FS, DHFL and Indiabulls faced issues which slowed down NBFC lending which is a big driver of the economy.
Central Bank Monetary Policy under Raghuram Rajan and Urjit Patel was excessively tight and that combined with high NPA’s and the NBFC issues led to a steady deterioration in economic growth . Shaktikanta Das led RBI did reverse the policy and pumped in significant liquidity into the system however by the time the wounds were too deep and the healing process has been very prolonged. What was not expected was that the government will lose focus on the economy as they pushed their non economic agenda post elections. The tax proposals in the budget were retrograde and there was a lack of acceptance of the slowdown gripping the economy. By the time they started responding by reversing some of their announcements and introducing the corporate tax cuts the economy had already entered a deep freeze.
Years of low food prices have led to a stress on the rural economy, tight liquidity hit demand in the consumer durables segment and poor consumer sentiment in general affected consumer non durables demand. Governments focus on Infrastructure Investments also moderated with one big segment i.e. road construction which was driving the economy in a big way slowed down significantly. Real Estate demand which is again a big employment generator as well as creates demand for a lot of products across the board be it cement, sanitaryware, wires, lighting, tiles etc etc remained subdued even in 2019.
Government measures in general have been reactive. For example the NBFC refinance scheme to give liquidity to stressed NBFC’s was a non starter as the terms were onerous. The fund announced to complete stalled housing projects across the country has been a non started as I write and the payment of arbitration dues to infrastructure companies also has not moved ahead substantially.
The real reform was the corporate tax cut where it gave direct benefit to the companies. The other area where things have actually moved over the last couple of months has been the refund of GST dues that have been stuck and tax refunds which has picked up substantially. The announcement of strategic disinvestment of BPCL and Air India is positive however will take time to play out.
Globally we have seen a huge rally in the US Markets where valuations have now gone up hugely this year. The S&P 500 is trading at 18.5x analysts forecast for 2020 earnings of $178.24. The only other time in the past 10 years the Index’s forward PE multiple has been higher was in late 2017/early 2018 before the markets fell about 12%. As such this becomes a risk in the short run.
News flow on Brexit, US China Trade deal, Crude Oil Market dynamics created volatility throughout the year 2019. With the UK Elections done we will see Brexit play out. The US China Trade deal is done as far as the easy part goes. However there is a lot of ground to be covered and will need to be seen in 2020.
AS WE LOOK FORWARD
2020 will be a year of risks and opportunities. As we enter into the new year I see excessive optimism in the Equity Markets globally and also in the large cap space in India. There is a theory floating around that valuations do not matter and quality stocks can also be bought at PE Ratios of 100X. Well history has show us that this doesn’t work. We all know what happened to stocks which traded at euphoric valuations in the years 1999 as well as 2007. This does not mean that these stocks will crash, however the possibility of below par returns for the next two years is now high in this set of 20-25 stocks.
The first few weeks of 2020 should see some correction from euphoric levels. The current inflation expectations globally are too low and as these expectations trend up they could create volatility in equities.
The negatives as far as India goes is that we might not get more monetary easing as is generally believed.
The positives could be more proactiveness from the government on the economy which could be in the form of more reforms, infrastructure investments as well as personal income tax rate cuts. The ability of Indian banks and NBFC’s to lend is also much better now after the clean up of the balance sheets and abundant liquidity. This is definitely a positive for growth. The other positive which will drive consumer demand is the pick up in food inflation after several years which will boost rural incomes. The rural economy typically does not benefit from lower interest rates but does benefit when food prices trend up. The rabi crop outlook is also good which combined with higher prices should boost rural incomes further.
The earnings expectations for the year 2020-21 for the Nifty and Sensex are at 23% which seems too optimistic at this stage. Consensus EPS for that year for the Nifty is currently trending at around 670, however this will require a good pickup in the economy and sustained high margins. More realistic could be around 640. As such fair value at 20X will give a Nifty Target of 12800, barely 4% above the current levels.
However the opportunities in India as always will be stock specific and that is what investors will need to look at to outperform. Outperformance was tough in 2018, however it will be easier in 2020.
Wishing everyone all the best for the New Year. Have a great year and I will write more later.