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Alpha Edge, June 2017 - Yawning Gap!

Equity markets continue setting new highs on hopes of GST implementation, early monsoons raising the prospects of a good harvest and revival in earnings. Even though this month the picture was a little different with Mid and small cap indices correcting marginally. The same was warranted considering the premium over its large cap peers that it is trading nowadays.

Global stock markets too are hitting record highs and Asian markets are close to their best levels in more than two years as upbeat data from US and buoyant European factory growth boosted investor optimism. In most of the markets globally, market psychology has swung dramatically over the last 12 months. In early 2016, investors were worried about low liquidity globally, risks of interest rates hike and a U.S. recession, but the narrative has veered in recent months toward the awakening of animal spirits. We still believe that the truth falls somewhere in between — that the recovery in global economy is resilient, but mediocre.

From a domestic stand point, the biggest puzzle that the economists are grappling with in 2017, is the growing divide between the pace of underlying economic recovery and strong GDP numbers over the last 6-8 quarters. However in the March quarter, the scars of demonetisation finally became visible as GDP growth came in at 6.1%, lower than 7% of the previous quarter. Major part of this growth was contributed by government expenditure. This is more of a bad patch, as one would have thought with slowdown in consumption and manufacturing, however, it was not as bad as it was presumed to be. Investments have been flagging, with growth still driven by consumer and government spending. Slowing down of manufacturing growth to 5.3% is an evidence of the same. Weakness in private investment could be attributed to local and global excess capacity and leveraged corporate balance sheets. For underlying growth to pick up meaningfully, investment must be revived and issue of bad loans must be resolved, because, in our opinion no economy can grow sustainably with banks struggling.

As far as the latest earnings season is concerned, the results have been more or less as per expectation. The expectation itself has been toned down when compared to what it was at the beginning of financial year. We are definitely seeing some improvements in the numbers especially on the revenue side. Equity markets are flirting with all-time highs. The market valuations are clearly indicating that expectations & sentiments are way ahead of the pace of the recovery of earnings. A thing that cannot be ignored is that India still remains one of the best economic stories in EM’s, with a reform focused stable government entering the last two years of its term. With long term growth drivers still in place and getting better, current valuations can no longer be considered cheap and higher expectations could result in volatility in short term. We remain a bit cautious in the short term. We recommend adding to equities very slowly from a medium to long term horizon.

 

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