Market outlook: Brace for a choppy FY18, earnings growth key

For markets to sustain at higher levels, a pick-up in corporate earnings is essential, analysts say

The current financial year has been good for Indian equity markets that surged nearly 17 per cent, with the Nifty50 index hitting its 52-week high of 9,218 during this period. While investors hope the momentum will be carried into the next financial year, 2017-18 (FY18), experts say the implementation of the goods and services tax (GST) from July 1, among other factors, will be the key to how the markets react.
 
Experts, however, expect the markets to be choppy or range-bound in FY18, at least in the first half.
 
“I am slightly cautious towards the implementation of the goods and services tax in July 2017, which, I believe, can throw up execution issues. There could be some de-stocking by the companies ahead of GST implementation, and we need to wait and watch to see how things work,” says Andrew Holland, chief executive officer, Avendus Capital Alternate Strategies.
 
How well the GST is implemented and how companies react during this period will also have a bearing on corporate earnings. The monsoon and its impact on inflation is another key event. Incidentally, both events will overlap in July, which, in turn, could trigger volatility in the markets. Already, the initial forecasts suggest the monsoon to be below normal.
 
At the global level, events such as the outcome of French elections, policies adopted by the US president, and oil price trajectory will impact sentiments in FY18. Flows to the equity markets — via foreign investors and domestic mutual funds — are crucial for the market momentum to continue and will be influenced by these events.
 
Experts remain confident about the country’s economic growth prospects, even as they sound caution over global headwinds.
 
“The Indian economy is definitely expected to perform better than it did in FY17. The impact of demonetisation has been limited, reports show. We expect growth would be in the higher range of 7.5–8 per cent next year as against 7.1 per cent in FY17, as per CSO. This should augur well for the markets and foreign portfolio investor (FPI) flows,” Madan Sabnavis, chief economist at CARE Ratings says, citing a report.
 

“The only domestic risk factor would be the monsoon. The government is well on its way to implement the GST, which should give more confidence to investors. At the global level, there is uncertainty on the course of Brexit and the evolution of economic policies in the US that can affect investment decisions taken relating to emerging economies,” he added.
 
Valuations on a 12-month forward basis are now at around 17.3x earnings, or about one standard deviation above the mean, analysts say. Earnings need to pick up going forward for the current momentum to sustain.
 
“Delivery of the projected earnings growth is crucial for valuations to sustain and expand. While FY18 would benefit from a low base of H2FY17 (demonetisation impact), there are two important near-term earnings headwinds to watch for: (a) inflation in commodity prices, which could erode margins for sectors like autos, consumer and cement; and (b) the implementation of GST, which could impact earnings for a quarter or two (inventory adjustment in trade, initial implementation hurdles),” says Gautam Duggad, head of research at Motilal Oswal. Holland of Avendus expects the earnings to grow around 10-12 per cent in FY18.
 
He remains bullish on private banks, consumer-related sectors and those having an exposure to other global markets; and remains bearish on information technology, pharma and telecom sectors. The dark horse could be the real estate sector, but it is a long-term play, he says.
 
Going ahead, analysts expect domestic flows to be resilient, though they don’t rule out month-on-month volatility.
 
“Our economics team believes that flows to the stock markets could potentially increase to $55 billion in FY18-19 versus $28 billion in FY16-17. Global events like the French election will need to be watched out for – any change to direction of EM flows could impact India negatively as well,” says Surendra Goyal, head of India equity research at Citigroup in a co-authored report with Vijit Jain.

Markets could be a rough sail

• The current financial year has been good for Indian equity markets that surged nearly 17%
• Experts expect markets to remain choppy  at least in first half of FY18 
• They say implementation of GST in July, among others, will be key to how markets play out
• Besides GST, monsoon rains and their impact on inflation will be another key event
• GST and monsoon rains will overlap in July, which could trigger volatility in markets
• Initial forecasts suggest monsoon rains will be below normal