“When the going gets good, tough gets questioning”. It is this peculiar scenario, which I find our equity markets are in. Or for, if you somehow question the market performance, it is with great conviction one is given an explanation that “This time its different” or “Liquidity is too strong”. With arguments being made that higher valuations are the new norm, it is a time to ask, when going is this good?
Does the new norm of higher valuations reflect the worth of the businesses and/or the fabulous macro opportunity we have on our hand and / or it is a reflection of the bottoming out of global growth?
What we have been witnessing in previous four financial years is a typical case of excel sheet extension of earnings growth where at the beginning of every year we start with the hope of high teens earnings growth to realise that by end of the year, we are not even reaching double digits. However, our eternal hope (read liquidity) has helped markets to absorb shocks, both local and global to keep performing.
Inspite of this consistent track record of the street misjudging the numbers, I still will place my bets on double-digit earnings growth in FY 19 (not FY18) led by consumers, materials and banking and finance.
In terms of valuations, we have seen price to earnings multiples expand making it difficult to have sizeable room of error on future earnings performance. While one can attribute various structural reasons for this expansion, at the end, it always seems “It's different this time around”.
Coming to the upcoming quarterly numbers, it is likely to be a distorted quarter for the domestic economy-centric companies. Consumer-facing and dealer & distributor oriented sectors are likely to see disruption, as destocking happens and channel inventory clears.
Although it will be seen as a one-time affair, it is important to closely watch how the subsequent restocking shapes up. In terms of the globally exposed sectors, the results are expected to be in line with what the streets are forecasting. It is difficult to put a growth number both for the current quarter and the year as there are lots of moving parts. It would be an opportunity to look for quality businesses, on price correction, for any disappointments in numbers for the current quarter, especially in consumers, both staples and discretionary.
While earnings are one of the most important variables, a lot of emphasis is given on the “ideal macros” for justifying the rich multiples. It is indeed true, that we have seen accelerated reforms and tight fiscal management, which has revived the health of the economy, resulting in attracting investments both from local and global investors. Besides, the ideally placed demographics, development focused Government and entrepreneurship spirit have helped to improve the wider sentiment in the economy.
In my view, the potential of the economy has always been there. It is now since few years, that the catalysts, which were missing earlier, have been put in place for sustainable growth. However, for equity markets, we still have to see whether the growth in the economy leads to growth in earnings performance, which in my estimates is likely to be patchy.
For the performance of equity markets from here, barring any black swan event, my view is that future performance will likely mirror closely the earnings growth, as the rerating story is largely played out. It would thus be patchy and volatile.
For investors looking to trade shorter term, it is going to be tough as usual. However, for longer term (five years and more) there is no asset like equities to deliver inflation beating performance. However, it is important to be on look out for ever changing environment and subsequent variables and keep questioning status quo.
The author is co-chief executive officer at Avendus Capital.