Bracing for macro-data, news flow

This fortnight is likely to be driven by macro-data and news flow. The bulk of Second Quarter 2017-18 (Q2, July-September 2017) results are in. The GDP data is released this week. The Reserve Bank of India (RBI) has a policy review next week and PMI (Purchasing Managers’ Index) data will also come in.
 
Abroad, the US Federal Reserve has a policy review next week and a new Federal Reserve chairperson is also due to be confirmed. The OPEC meets this week to reach consensus on crude production in 2018. China stocks had a meltdown on Thursday. Angela Merkel’s government is struggling and there’s the possibility of a snap German election. The Brexit drama continues.
 
The markets must discount disagreement between S&P and Moody’s on sovereign ratings. There’s an important change, via ordinance, in the IBC (Insolvency and Bankruptcy Code). Beyond the economics, many traders will sit on the fence until the Gujarat and Himachal election results.
 
The Q2 results were lumpy in sector contributions and had a positive bias for larger firms. A study by Business Standard of 1,850 listed companies shows overall revenue grew 8.7 per cent year-on-year while net profits declined YoY by 2.6 per cent. The Nifty’s net profits were up by 12 per cent. Those 50 companies accounted for over 80 per cent of the combined net profits of the sample (up from 78 per cent YoY). There have been some cuts to consensus estimates.
 

Financials and energy generated most of the revenue growth and profitability. Excluding these two sectors, net profits would have fallen 7 per cent, and revenue growth reduced to 7 per cent. Automobiles and metals also did well.
 
The goods and services tax (GST) hit smaller firms harder. They have more informal elements in the supply chain, comparatively greater need for working capital and less accounting support. Deseasonalising the festive season’s impact is tricky. September 2017 benefitted from an early season. There will be a low base effect in the second half, due to demonetisation.
 
Financials and energy always have volatile earnings. Banks have latitude in non-performing asset (NPA) provisioning, which affects profits. NPAs rose through Q2 albeit the pace of new NPA creation decelerated. NPAs are expected to rise through the second half (October 2017-March 2018) as well. The IBC ordinance excludes defaulting promoters from bidding to take back control of their assets. This could lead to deeper haircuts.
 
In energy, crude, coal and gas price movements impact earnings. Crude prices are hitting two-year highs. OPEC put together a deal in January 2016 where member-nations and Russia (which is not part of OPEC) agreed to cut production by 1.8 million barrels/day until March 2018. Saudi Arabia is pushing to extend that deal until December 2018. It’s hard to guess if that will happen and how the shale industry will respond.
 
If crude prices stay high, it’s bad for India of course. It negatively impacts government finances and also forces inflation up. Since September 2014, low crude prices allowed the freeing up of retail pricing and the hiking of excise rates. Higher crude prices mean political pressure to not raise retail prices, given a spate of elections over the next 18 months.
 
The market is discounting the probability of higher inflation. The Consumer Price Index (CPI) rose 3.58 per cent YoY in October. The Wholesale Price Index rose 3.59 per cent. The RBI is likely to hold policy rates at status quo in December, since CPI inflation is closer to the lower end of its targeted “tolerance band” of 4-6 per cent. Higher crude prices could trigger a current account deficit (CAD) of 1.5 per cent for the fiscal, well above the 0.6 per cent registered in 2016-17. The CAD was at 2.5 per cent in June 2017.
 
The fiscal deficit is also likely to be well above the targeted 3.2 per cent since over 95 per cent of the target had been crossed by August as the government increased spending to maintain growth momentum. S&P’s refusal to upgrade the sovereign rating is, in part, based on its assessment of deterioration of public finances. Moody’s also reckons on a deterioration but assumes it will be transient. Guesstimates of the GDP Q2 numbers (due for release on November 30) range from just above 6 per cent growth to just above 7 per cent.
 
December is likely to see a rate hike from the Fed and Brexit-related fluctuations in the GBP. The Euro might also be volatile if there’s a snap election in Germany. That all adds up to volatility in rupee rates and yet another reason for the RBI to be cautious. Bond yields could harden if the RBI maintains status quo and the rupee dips.
 
Equity valuations are off the scale. The Nifty is at a current PE of 26.5. The Nifty 500 is an unheard-of PE of 31-plus. Foreign portfolio investors, who pumped in vast quantities in November, could pull back until the Fed’s attitude is clarified. Domestic investors remain gung-ho. The mutual fund corpus is rising at about 50 per cent YoY. Technically, the market still looks very bullish with higher troughs on corrections and analysts calling for an end-of-year target of Nifty 10,600.