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First signs of the good times

Even as a full-blown recovery in earnings will be key for markets, many other risks seem to be abating for now

First signs of the good times

Markets like forecasts, especially optimistic kinds that tend to make headlines. After a highly forgettable and tough 2018, I guess, investors need inspiration to return to the markets. Strangely enough, after a correction or a challenging phase in the markets, investors pack their bags and run when they should actually be tanking up on the same stocks they own, albeit at lower prices. It is for this reason that philosophy and inspirational quotes are tossed around frequently in these times.

Given that the first half of 2019 is expected to remain volatile for equities, most retail investors are cutting back on their exposure to equities. But that could well be a mistake, as many of the risks that surfaced in 2018 are beginning to clear now. Last year, markets faced several risks, from rising crude prices, escalation in trade tensions between China and the US, richly valued mid and small caps, and rate hikes by the US Federal Reserve. Interestingly, some of the risks have abated for Indian markets and yet nobody seems to be seeing the good news. Yes, undoubtedly some companies are facing bankruptcy proceedings, the IL&FS crisis continues to unravel and some promoters are facing serious liquidity crunch. But these are a part of the picture and not the entire picture.

So what has changed since we exited 2018 on a very sombre note? For starters, in February, emerging markets have received $25.6 billion from foreign portfolio investors, of which Rs 16,000 crore has come to India. In contrast, foreign investors had sold stocks worth Rs 21,000 crore between April 2018 and February 2019. While Indian markets are no longer driven by foreign money, the return of the whimsical global investor is a good sign.

Other than this, there are three other developments that are positive for Indian equities. Crude oil has cooled down after the highs it hit last year. With demand remaining moderate, a sharp uptick in oil prices looks unlikely. Oil analysts expect prices to inch up gradually. The other key risk facing global markets was an aggressive balance-sheet contraction by the US Federal Reserve and a series of rate hikes. Markets seem to be discounting such a possibility. Also, a trade deal seems possible between China and the US, which is a huge positive for exporters. Market experts are of the opinion that under the stewardship of the new governor Shaktikanta Das, the central bank is more aligned to the government's growth agenda. It has already cut interest rates by 25 basis points in February and is working to improve liquidity conditions in the banking sector. The Reserve Bank of India has also removed three banks from the framework of prompt corrective action (PCA), which restricted them from lending.

If you cut out the optics and hyperbole, markets are essentially driven by key factors like earnings growth, liquidity and macroeconomic indicators. While earnings recovery for the broader markets may not have happened yet, sectors like IT, staples and private banks have reported healthy profit growth. On the other hand, sectors like materials, pharma and telecom are working out their own problems. Given that volatility could remain high in the near term, risk-averse investors could look at building a portfolio that is tilted in favour of large caps.

The outcome of the general election has for long been touted as a key risk for markets. Unlike 2013, most strategists and psephologists are not willing to call the elections yet. In its strategy note, dated 6th March, Morgan Stanley says fundamentals appear to be at the start of a new upcycle, while valuations are at mid-cycle. With PMIs expanding, corporate revenues at a 20-quarter high and corporate credit growth at multi-year highs, Morgan Stanley believes that the ballot may fade in significance as 2019 unfolds if it is right about the growth cycle. In January, Nikkei India Manufacturing Purchasing Managers' Index (PMI) hit a 14-month high of 54.3 in February, up from 53.9 in January. India's core output growth continues to remain weak at 1.8 per cent in January, hitting a 19-month low. Economic growth too was at 6.6 per cent in the December quarter of FY2019.

However, economists believe that 2019 is showing promise as government spending has accelerated. Motilal Oswal has developed its in-house economic activity index (EAI) to track growth. According to the EAI, consumption in January 2019 grew at 10.7 per cent, which is a 20-month high. Consumer growth in January came on the back of a strong 50 per cent year-on-year growth in fiscal spending. Economists now expect March quarter growth to be robust and the full-year growth to be around 6.9 per cent to 7 per cent.

Just as markets overshoot on their way up, pessimism tends to find takers even when the worst is over. And it is for this reason that many of the positives are being ignored by investors.

The author is the editor of Value Research Stock Advisor.