At the outset we would like to wish our members a very Happy Diwali. May the festival of lights bring in all the wealth and happiness to one and all.
With the strong improvement in macros, India remains an attractive destination for the foreign investors. India’s annual FDI inflows have shown decent increase in the last three years indicating strong backing of foreign investors to the policy decisions taken by the government.
With the recent interest rate cut, India’s 10 year G-sec bond yields of 6.72% have fallen to 12 year low. The low inflation, improved liquidity, and subsequent rate cuts have seen ~100bps decline in the bond yields, in this calendar year. Inflation has played a major role in lowering interest rates. Owing to the supply glut and weak demand, crude prices have tanked from more than $100 per barrel in March 2014 to current $51 per barrel. Crude oil forms more than 30% of the country’s imports and any decline in crude oil is a boon for the Indian economy. A normal monsoon this year has also ensured inflation remains low for next year, giving RBI more headroom for further rate cuts.
Meanwhile, the world is in turmoil. From China to Europe and Brazil to the Middle East, every country is facing political, demographic and financial system issues while being under the climate of a macro slowdown. To deal with such a situation, central banks are printing large sums of money and distributing it to the public to stimulate economy, but the results are not encouraging. Instead, falling negative yields on bonds are creating unsustainable asset bubbles. Real and sustainable growth seems elusive almost everywhere, except perhaps in India today.
Consumption continues to remain a dominant theme in India. Our domestic demand is expected to improve due to a strong revival in the rural economy. This year’s Kharif production is expected to be strong with food grain production reaching to a record 270 million tons, 7% higher than total food grain production of 252 million tons in FY16.
In the past two years, rural economy suffered significantly as the agriculture production took a hit due to drought and decline in Minimum Support Prices (MSP) of food items by the government. This led to a decline in earnings of the farmers impacting the rural economy. This year, however, the rural economy is on strong recovery path with a robust growth in crop production and rise in MSP.
Overall, the domestic consumption is expected to improve with the increase in demand and this is already reflected on sales of automobile and white goods. The traction in retail loans has also picked-up over strong recovery in consumer sentiment. The recent rate cut will further accelerate the consumer demand as loans will become further cheaper. In the last two years, RBI has cut the interest rates by 175bps, which has provided a strong cushion for consumption growth. Overall, consumption is expected to remain a strong theme in the Indian markets.
The Sensex in CY2016YTD has appreciated by ~6%, but has outperformed the US markets by ~1%. During this period, Chinese markets have declined over growth concerns in their economy. We believe that the economic revival, improvement in the consumption and further possibility of interest rate cuts will increase corporate earnings going forward. Owing to this, we expect Sensex to clock ~14-15% CAGR in earnings in the next two years.
As the current level, Sensex is trading at 15.8x of FY2018E earnings. As the corporate earnings pick-up and economy gathers momentum, we expect Sensex to reach new heights. However given the run up in the markets in the recent months it is likely to make a minor correction before resuming its northward direction.
We have identified 3 stocks with the unique business model before Diwali and expect it to provide good returns in the medium term.