Of late, the rich market valuations have been drawing a lot of attention, with the market trading 23% above the long-period average. This author discusses the key risks to markets in 2018.
In our view, the sustenance of healthy macro fundamentals and liquidity has driven valuation re-rating even without concurrent improvement in micros (earnings growth). As regards the political landscape, in the first major state elections post GST implementation, the BJP, the ruling party at the centre, has won Gujarat for the sixth straight term and Himachal Pradesh (HP) state elections with a comfortable majority.
Winning UP and Gujarat right after big structural reforms like demonetization and GST, which have created short-term disruption, reaffirms Mr Modi’s popularity and augurs well from the perspective of the reform, in our view. With the overhang behind, we expect the market to revert to fundamentals. H2FY18 should see sharp earnings recovery, led by a low base of demonetization and signs of pick-up in rural consumption, even as the macros have come off a bit with the rise in crude oil prices, CPI inflation and 10-year bond yields.
Here are the key risks/events that the markets face in the next year: Domestic growth:
2018 is less uncertain but still weak. Structural reforms have weakened near-term visibility on most macroeconomic parameters. While the windscreen should clear up through 2018, we believe growth could still be weak. Weak agricultural income growth may suppress broad-based consumption demand while at the same time helping financial savings.
An unclear outlook and low utilization should keep investment demand weak (new announcements lowest since 2004).
Global markets and economy: Global growth remains tepid, but for the first time this decade, estimates are no longer being revised downwards. European capacity utilization is at a post-cycle high, implying a pick-up in investment demand. With inflation staying low globally, the withdrawal of central bank accommodation is unlikely to be sudden.
Furthermore, with China’s retreat from export markets in polluting industries, market incentives, in the form of elevated margins, would have to stay higher for longer for supply to respond. This trend could last several years.
A turn in the portfolio: As the 2019 general elections get closer, state elections are likely to get more market attention. This has limited direct economic impact, mainly after the budget is presented, but changes in market sentiment may drive volatility. We still believe that one should be invested in the market despite the challenges and risks in the market.
(The author is VP -Equity Advisory, Motilal Oswal Securities)
