Need pick-up in consumer demand and investment expenditure to believe things have turned around

Joseph Thomas, Head of Research at Emkay Wealth Management, feels the Q2FY21 earnings season has been a positive surprise for the markets, especially given the fact that the economy is coming out of a severe pandemic-led lockdown.

“While the topline numbers may not look too encouraging, the EBITDA numbers reflect a different picture. The expected suppression of demand-led corporates to work aggressively towards reducing cost and the drive was well supported by subdued input price inflation,” he said.

He feels grabbing a higher rate of economic growth will happen only over the next three to four quarters.

Edited Excerpts:

Q: With the winning of Democratic Party’s Joe Biden, do you think risks like global trade war and some geopolitical tensions will ease in Samvat 2077?

What has been observed over the last five decades is that irrespective of the party or the president, the policies of the US in matters of defence and foreign relations remain more or less the same. It always has American interests at heart. But the individual traits and personal preferences of the president may have some bearing on the approach to various issues that crop up from time to time. As far as the trade and tariff war goes, it was an intense and aggressive encounter that happened between China and the US. It disrupted trade and commerce, and, in fact, precipitated a slowdown in some of the major economies including Europe and the US.

The Fed Chairman stated in no unclear terms that the trade war was one of the major risks to growth in the US. The European majors like Germany and France were under constant fear of tariff actions from the US when their economies were already in sluggishness. So, the US approach to trade and tariff with China was disruptive. But with a change in the presidency with a moderate thinker at the helm, the tariffs may not come down much, but the overall approach would be more likely one of constructive discussions and negotiations. This would be a relief from the global trade perspective.

What is more interesting to watch would be the follow-up action on the matter that China has been the source of the pandemic and it had suppressed early information on the pandemic to the detriment of the international community. Geopolitical tensions that we witness today have evolved over the last few years, and issues with Iran, North Korea, China-India border conflicts would be asking for resolution but may drag on, going by the nature of these issues. It would be unwise to rule out such eventualities as distractors to the economies and markets.

What could be the quantum of rate cut from the RBI in Samvat 2077. Will the RBI indicate change in its stance (currently accommodative) in Samvat 2077?

The Rate cut is closely linked to the rate of retail inflation indicated by the Consumer Price Index (CPI). The CPI for October is at 7.61 percent and food inflation is at 11 percent. Inflation has been consistently above the RBI’s target threshold of 6 percent. From fruits and vegetables, food inflation as moved on to other items of food as well, and this would mean that the high price level is likely to be more persistent than we expect it to be. RBI itself had indicated that only on deeper gains in inflation there could be any further rate action. Apart from higher prices, the government borrowing programme is also very large compared to the appetite of the market to absorb such securities.

Due to these factors, it is less likely that there would be a rate cut in the near future as conditions are not conducive for that. But what is more important than rate action is accommodative policy. RBI is likely to pursue the accommodative stance and ensure that there is sufficient liquidity in the system till economic growth revives in a sustainable fashion. Liquidity enhancement and not rate cuts have been the major plank of the RBI policy. RBI may be compelled to review the liquidity stance only in case of runaway inflation. In sum, there is room for expecting further rate cuts, but it would be reasonable to expect the RBI to continue with the accommodative stance of policy.

Q: Do you really feel the FY22 earnings would be robust on the back of better-than-expected September quarter earnings, and why?

The Q2FY21 earnings season has been a positive surprise for the markets, especially given the fact that the economy is coming out of a severe pandemic led lockdown. The net sales growth for Sensex companies, based on results announced till the end of October 2020, came in at -6.40 percent, and for Sensex ex-Oil & Gas and BFSI, it came in at 4.40 percent. While the topline numbers may not look too encouraging, the EBITDA numbers reflect a different picture. The expected suppression of demand-led corporates to work aggressively towards reducing cost and the drive was well supported by subdued input price inflation. The EBITDA growth for Sensex came in at better-than-expected 38.5 percent. The trend was similar for broader markets, with BSE 500 was reporting EBITDA growth of 67 percent. The EBITDA margin expansion for Sensex was reported at 983bps and for BSE 500 group was even better at 1132bps. The cost control measures, improving demand and supportive monetary conditions are expected to be earnings supportive going ahead as well. With overall growth likely to pick up the pace, and general economic conditions improving for businesses, the obvious positive impact on earnings can be easily visualized.

Q: Economic data points indicated that the economy is on the recovery path. What is your reading on the same and what do you expect the economic growth by end of Samvat 2077?

The economic recovery that we are talking about is to be understood in a relative sense. During the pandemic and the consequent lockdown, the level of economic activity reached its lowest levels and we had seen the GDP contraction at 23.90 percent level, something that we have seen only once in a lifetime. The GDP contraction for the whole year is expected to be somewhere around 8 or 9 percent. In effect, this whole year is a time of negative growth, with some uptick in growth in the third and the last quarter of the current year. With relaxation in the lockdown and with many businesses opening their shops, things are improving gradually. But it may take much longer time to gain normalcy or the pre-pandemic levels in production and output, and therefore, employment. Therefore, in a relative sense, we can say that growth will be better, and that economy will gradually pick up in the next year. That is to say that it is from a bottomless chasm that we are making this ascent.

Grabbing a higher rate of growth will happen only over the next three to four quarters. The core sector numbers are looking good, Sept at -0.80 percent as against -7.30 percent in August. IIP for September is almost flat at 0.20 percent from degrowth of 8.00 percent in August. GST collections have improved. There has been some uptick in variables like auto sales, retail loans etc. A lot of this may be attributed to temporary factors like pent up demand which may well wane away over time. But there is obviously some revival in economic activity, but it may take time to go back to the high single-digit growth in GDP which we had seen years back. We need to see a pick-up in consumer demand and also investment expenditure, to believe that things have turned around in a convincing fashion.

Q: FII inflow has been strong in last few months after easing COVID-19 crisis. Do you expect the FII flow to continue in Samvat 2077 and why?

FII flows have picked up in the last few months. There are two reasons behind these continuous inflows. The primary reason is that the outlook for the domestic economy is relatively better compared to many other economies. And second, there has been a quantitative expansion in the US and Europe, and there is a significant expansion in liquidity in India too owing to the accommodative fiscal and monetary policies. The Indian Rupee has seen admirably stable all this while. Against this background, those who are saddled with liquidity for a reasonably longer time horizon are bound to invest into the domestic markets. This trend is not very strong now but may acquire strength over a period of time as the prospects of a sustainable recovery in India at a much faster pace is a strong probability. The second wave of the pandemic in the US and Europe is sowing havoc, and many of them are moving back into shutdown which is likely to stall the resurgence in growth in those territories. Indian businesses are perceived to be gaining from the reverses suffered by China in the recent past, and this shift in manufacturing and purchasing may give a fillip to the domestic economy.

Q: What are key global risks and triggers for the economy and markets in Samvat 2077?

There is going to be a change of government in the US, and the approach of the new government to various critical issues is a determining factor as far as the general direction that we make is concerned. There may be a more positive approach to climate change, issues concerning trade and tariffs, better co-operation between the US and Europe, liberalization of entry and visa norms for foreigners and immigration into the US etc. All these may also help reduce the scope for any geopolitical tensions flaring up into full-fledged conflicts.

The effective containment of the pandemic and the free availability of the vaccine also would be important in instilling greater confidence in people in general in keeping the establishments open with no real fear of the pandemic. This is required for avoiding future lockdowns and loss of productivity. The feeling that we are sitting at the edge will be completely eliminated. The will of the governments across the world will also be a defining factor in this matter.

The current uptick in the markets is, to a large extent, driven by optimism about future growth and the surplus liquidity conditions which is the result of accommodative economic policy. However, any rise in inflation may lead to a rethinking on the soft money policy and beyond a limit, central banks may hike rates in their efforts to bring price level under control. This may be coupled with a withdrawal of excess liquidity, a situation akin to the tapering of the quantitative easing initiated in 2007-08. This has the potential to erode quite a bit of the gain made by the markets so far.

The border issues between India and China needs a resolution, as intermittent and protracted conflicts may cloud the initiative for timely business decisions and speedy economic recovery. The best climate for business is peace.

Q: The market gained around 10 percent in Samvat 2076. Will the market give double digit return in Samvat 2077 and what are key driving factors for those gains?

With likely improvements in the economy and the rise in GDP and earnings, it is but natural to expect higher returns from equities. But let us not anchor the return expectations to either high or low double-digit returns. Given the low-interest rates, and the returns from fixed income portfolios moderated substantially to mid or high single-digit, the return expectations from equities too may require some revision from the earlier high double-digit to probably mid double-digit.

The performance of businesses would depend on a number of factors which we had discussed earlier, and therefore, the performance of markets too. But to have better certainty about the risk-return outcomes, care should be taken at the time of designing and constructing the portfolios. Actively managed portfolios with a diversified profile, in asset classes and sub-asset classes, with an impressive track record, is key to the performance of investment portfolios.




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