After a fall in September, Indian markets had a strong comeback in October. November has been a month of consolidation. Markets continue to be focused on Indian fundamentals as domestic money is the key driver, and is now less influenced by global happenings.
Globally, the month of November has seen a bounce back. China saw relaxations in Covid restrictions. In the US, lower than expected inflation number has raised hopes of a policy pivot. European gas prices have fallen as they seem to be well provided for winters. Logistic costs have come down as well. However, it does seem that some of the positivity may be pre-mature and inflation may yet prove to be more stubborn.
One common query that I have been receiving is about the impact of global recession on Indian economy and Indian markets. Let me share a few thoughts on this topic:
Indian exports are around 18-19% of the economy. A 2-3% slowdown in the western world, our major market, might have an impact of around 0.5 to 0.6% on India’s economic growth. Even this estimate may prove to be large, given that our largest export to the west is of software services which is an order book driven business and once orders are received, the execution is usually time bound. The impact on this count could hence be muted. Moreover, there is a good chance that the west does not see this extent of slowdown.
We could evaluate the impact from the lens of trade deficit. This is where it gets very difficult.
- A slower world growth has resulted in lower commodity prices. Even the price of oil has fallen below USD90 for brent. A USD10 fall in oil prices is a USD12/13 billion saved for our country. Improved global growth prospects may increase the price of commodities, particularly oil, very sharply given the tight supplies and may impact India negatively.
- On the other hand, if our export markets grow slower than us, then our already large trade deficit would become larger.
Hence, there are two conflicting forces at play here. It may be best to track the level of the forex reserves which have been increasing over the last month It has acted as a dam against the volatility in the external world. If forex levels are high enough to finance multiyear current account deficit, we can sustain business as usual We believe that we are comfortably placed given that we have over 4 years of current account deficit cover.
The small drag on growth that the global slowdown would cause can be countered by the cyclical tailwinds the country enjoys. Consumption, which is a larger part of the economy and has been the growth driver, could increasingly see capex and stimulate good competition. Indicators such as capital goods imports, industrial consumption growth, etc, remain strong. Capex should sustain given the healthy corporate balance sheet, improved profit margins, strong banking system, growth oriented policy making and sustained improvement in capacity utilisation. Higher outsourcing by European nations may help as well.
Government policy direction remains growth oriented. Free Trade Agreement with UK might be signed soon. RBI has infused some liquidity into the banking system. Moreover, FY24 might experience strong push via higher government spending given that it would be the year before elections. This would support domestic growth and help address some impact of a global slowdown.
Q2 result season has ended. The season was stronger than expected on profits.
- Our Universe earnings declined 5% YoY (vs est. of 16% YoY decline) while for Nifty, it stood at a 9% growth (v/s expectations of flattish earnings). On a three-year basis (2QFY20 -2QFY23), MO universe/Nifty’s earnings posted an 18/19% CAGR, respectively. Continued strong performance in BFSI and lower than estimated losses in OMC’s drove the beat.
- Metals and O&G, posted a 67% and 29% YoY earnings decline, respectively. Excluding these, the Universe and Nifty posted a solid 30% and 33% earnings growth (v/s exp. of 30% and 28%), respectively, fuelled by BFSI and Autos. Cement and Healthcare sectors too dragged 2QFY23 earnings.
- Economy has opened up and costs have come back. Also, higher cost inventory was consumed in Q2. This impacted EBITDA margins which fell by 5.4% to 12.8%.
- In H1FY23, Nifty and our Universe posted 15% and 3% earnings growth, respectively.
- Post the result season, the nifty index EPS has been raised by 2.5% to Rs.837. We now expect the Nifty EPS to grow 14%/19% in FY23/ FY24. FY24 EPS is expected to be in the 950-1000 band.
Source: MOIE Research
Q3 results would have the benefit of a strong festive season sales and a relatively weaker base.
Improved prospects for alpha generation in the future
Alpha is the excess return that an actively managed fund delivers over the benchmark. The possibility of alpha generation improves if
- The breadth of the earnings is good: Breadth of the earnings which was narrow in the past is now widening. From covid lows, the large caps provided the first growth impetus. It is now being provided by midcap businesses. As economy sustains its growth momentum, microcaps and small cap businesses should start to see growth.
- New sectors emerge which have a long runway of growth: Themes like China+1 (chemicals space), defense (import substitution), engineering (on capex growth and European out-sourcing), ethanol and PLI beneficiaries, etc continue to provide strong growth visibility.
India is young but India is growing old too
India has long been seen as a young country and it is. However, the number of people over the age of 60 is already increasing at a faster pace than any other age cohort. In fact, growth of demography upto the age of 20 is quite stable (even declining). This trend is expected to accelerate as we move forward.
The point is that while India would continue to be a large market for youngsters who are aspirational, it would increasingly become a large market for services that the elderly demand. Medical services definitely would score high on this.
India is already the pharmacy of the world and produces the cheapest generic medicines. Government of India has extended PLI schemes for the APIs that were not manufactured in the country. This will support the eco-system of medicines in the country. Over time, this space has created a large amount of wealth.
Also, increasingly hospital services similar to western standards are increasingly coming up in the corporate sector. Interestingly, the cost of treatment in India is a fraction of the west, as the table, which is indicative, below shows. This has opened up an interesting opportunity for the segment. Not only would it cater to the growing population of seniors in the country, but could also become a destination for medical tourism.
We are clued in on this trend and hospitals have a meaningful presence in our portfolios.
The past month saw the end of a relatively good result season. Earnings estimates improved at the end of the season. Globally, inflation data seems to be getting better and there are hopes of a Fed pivot. Indian economy continues to be robust and the capex cycle continues to remain strong.
Inflation which improves the competitiveness of a domestic economy is good. For example, higher oil prices increase the growth in the middle east. For India, supply disruption driven inflation or inflation in oil is bad. However, inflation in agri produce is good as it improves the rural economy and India is a marginal net exporter here. Similarly, inflation on account of movement away from China is also good. This allows some profit margins to domestic manufacturing base. India Inc. had seen a sharp dip in margins over time and margins are recovering now, providing tailwinds to earnings.
With better data, while sentiment towards equity has improved, our thoughts on valuations remain the same as before.
We do expect the market to consolidate for some time, given that the bond markets seem to be relatively better poised at the moment. A few months of consolidation or a fall in bond yields would make equity relatively attractive again.
How are our portfolios positioned?
As explained last time, our house is focused on spaces which have participated to a lesser extent in price compounding w.r.t. profit compounding while offering high quality character. We believe that this space offers much better risk reward equation towards delivery of preservation and growth objective especially as a part of a diversified portfolio.
We are an equity focused house and our portfolios demonstrate our conviction. Investors would note that our portfolios are now mostly close to 30 stocks with meaningful weightage across the portfolios. They would notice our portfolios getting balanced on sizing of positions and sector representations. We are striving to make our portfolios more balanced, for the risk we are able to identify, to ensure a sustainable delivery of performance to our investors.
Executive Director – Motilal Oswal Asset Management Company Limited
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Very beautifully expressed