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Do equity fund investors also need to temper expectations in 2018?

15 Mar 2023

 

What exactly is the investment outlook for 2018? There appears to be a consensus that while the index may not do a great deal, there will be a lot of action in specific stocks. Therefore the focus will be on specific stocks rather than on the index per se. But the bigger challenge is about investor expectations. Consider the 5-year Nifty chart below..



As can be seen from the above chart, the Nifty has gained over 50% in the last 2 years and that has built strong expectations around the Nifty getting to much higher levels in 2018 too. However, there are 5 reasons why investors and investment advisors must tone down their expectations from the equity markets for the calendar year 2018..

1.  Global overhang of Fed rate hikes..
As the Fed chairman, Jerome Powell, has admitted; the real question before the Fed is whether to hike the rates 3 times or 4 times during the year. The US GDP growth is likely to be around 2.7% during the year and the labour market is likely to be buoyant with just about 4% unemployment. With the government wanting to tame speculation and inflation in the economy, we could have a situation where the Fed could hike rates by up to 100 basis points during the year. That will have two implications. Firstly, in terms of fund flows, it could mean that fund strategy could increasingly become risk-off and prefer the safety of US debt which will anyways offer more attractive yields. Secondly, it will force a lot of economies, including India, to also increase domestic rates and that could prove to be a dampener for markets.

2.  Global currency wars could be the big overhang..
What do we understand by currency wars? As growth opportunities improve there will be a rush among emerging markets to weaken their currencies to make exports more attractive. In fact, one can expect China to take the lead. Back in September 2015 we did see a kneejerk reaction of a Chinese devaluation on Indian markets. If China was to attempt anything close to that, then we could see a negative impact on Indian markets. Let us not forget that global liquidity could also tighten if the central banks start tapering their bond portfolios.

3.  Oil prices and domestic inflation are a bad combination..
Indian CPI inflation is already headed above the 5% mark and most estimates are expecting to stay at elevated levels. With food inflation coming back and oil prices inducing secondary inflation, we could see higher inflation in the current year. That means interest rates will stay flat to hawkish. That is not really good news for India. But the biggest macroeconomic worry is on oil prices. Oil is hovering above $65/bbl and Brent is likely to cross the $70/bbl mark again during the year. That means further pressure on the trade deficit which has already crossed $16 billion in the month of January 2018. A widening fiscal deficit is also likely to put pressure on the INR.

4.  PNB fiasco has queered the pitch for Indian markets..
It started off as a very specific NPA issue but is now looking to snowball into something bigger. That is because, the size of the PNB scam has already crossed $2 billion and we are still counting. It has raised a big question mark over the actual health of Indian banks, especially because of the kind of lateral spill-off effect that the case could have. Remember, banks and financials constitute nearly 33% of the Nifty and an overhang on the banking sector is not great news for the index overall. We expect this case to drag on and remain an overhang for the sector as a whole and the market too.

5.  Valuations are elevated and growth needs to keep pace..
Indian equity indices are already quoting at above 23 times trailing earnings and there has been a big bet is on the earnings gathering momentum so that the forward valuations can be justified. The big question mark, therefore, remains over the future growth projections. If actual growth does not keep pace then the valuations may again begin to look expensive. And growth could be a concern if interest rates harden during the year and the retail inflation stays elevated.
So, what is the key takeaway for investors? Investor expectations in 2018 must be largely toned down. 
Expecting the Nifty and the Sensex to repeat the performance of the last 2 years would be a tad too optimistic. While there will still be individual outperformers, the market overall is unlikely to repeat the performance of the last 2 years. For fund managers and portfolio managers, the big challenge will be to manage investor expectations in 2018 and try to keep it as realistic as possible!
 

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