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India Strategy: Markets Meter; IDFC Top Picks - Interesting times ahead!

Indian markets: For Indian equities, CY18 was marked by tightening global liquidity, rising yields and volatile commodity/currency markets, which led to outperformance in ‘certain growth’ and quality stories (causing Nifty 50 to outperform BSE mid cap index by ~17% in CY18). IT was the best performing sector (finding support from ~8% depreciation in rupee and robust deal wins, aided by strong global growth momentum) followed by FMCG (which benefited from relatively stronger rural demand). 2019, has begun at an interesting juncture with, a) General elections expected in May 2019 (political uncertainty is up by a notch compared to Dec 2018 levels, post three key state election results), b) brent (at US$61/bbl) is ~30% lower than its recent peak (despite a 20% up-move from recent lows of US$50.5/bbl), b) rupee has appreciated 6% from low of Rs74.4/US$, d) concerns over global growth slowdown have garnered heat on the impact of trade wars on China, possible cyclical weakness in the US economy and Brexit impact, e) Central banks’ balance sheet tapering is expected to continue, albeit at a slower pace. On a fundamental note, we expect lower crude (if it sustains below US$65-70) to support margins for India Inc., disposable income, inflation, current account balance, fiscal deficit with a lag of 3-4 months. Currently, Nifty 50 forward PE is within long term average and +1 standard deviation (SD) band and looks relatively comforting. With this backdrop (uncertainty on elections, comforting valuations, possible benefits from lower crude), we would encourage buying long-term conviction ideas on corrections. However, we acknowledge near-term movement will be clouded by volatility.

 

Global Overview: We believe the global economy is slated to see tough times ahead, led by: a) expected growth slowdown in China, led by concerns over trade wars, b) cyclical weakness in the US economy, as it enters 2019 with the longest running growth cycle as the sugar high from recent tax cuts fades away, c) Brexit concerns for the UK economy, d) Populist challenges expected in the European economy. We expect these concerns to weigh heavily on markets, at least in the near to medium term.

 

Key themes and IDFC view: India’s external segment has seen a sharp turnaround, supported by weakness in crude prices and a stronger rupee. We expect benefits from these to reflect in current account balance, fiscal deficit, interest rates, inflation - albeit with a 3-4 month lag. This also bodes well for economic growth, disposable income and India Inc. margins. Hence, we believe near-term volatility or weakness in markets should be used to accumulate high quality names. We continue to prefer a) high-growth high-quality stocks and b) rural consumption story, as it finds support from reasonable Kharif output, strong loan growth in agri and allied activities and better targeting of government expenditure (though weak Rabi sowing remains a key risk). We anticipate tactical weakness in urban consumption (as 7^th CPC benefits fade out) and would like to highlight early green shoots for revival of private capex, as indicated by our scorecards (led by uptick in capacity utilisation, fall in system gross NPAs and uptick in outstanding industry credit, more details ). With this backdrop, we upgrade financials to Overweight (OW) from Neutral and downgrade IT and metals to Neutral from OW.

 

Sector Weights: IDFC sector weights as follows: a) OW: Banks, Consumer Goods, Automobiles, Engineering and Capital Goods, Construction and Media; b) Neutral:, Cement, Chemicals, IT, Metals & Mining, Power, Pharmaceuticals; c) Underweight: Real Estate, Oil & Gas and Telecom.

 

Changes in IDFC top picks: We have replaced Coal India and AIA Engineering in IDFC top picks with: a) Asian Paints (stable volume growth and likely margin improvement on weaker crude), b) Aarti industries (quality name with strong growth momentum, led by 14-15% volume growth and improved product mix) and c) KEC International (strong order wins and revenue visibility).

 

IDFC Top Buys:

Large caps: ICICI Bank, Maruti Suzuki, L&T, Asian Paints, GAIL, Hero MotoCorp, Dabur, Aurobindo Pharma

Small and mid caps: Aarti Industries, KEC International, Indian Energy Exchange (IEX)