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2018 Was A Year Without Alpha!…Will 2019 Be Different??

2018 was a year without alpha!…Will 2019 be different??

2018 was a turbulent year for the markets in general. We started off on a cheerful note- propped up by the exuberance of the 2017 rally, things started going downstream very soon with a meltdown in mid cap and small caps, NCLT cases, an NBFC liquidity crisis spearheaded by IL&FS, the global sturm-und-drang created by Donald Trump and finally our local political issues that created some noise in the markets. The FPIs sold off trimming their EM exposure while domestic flows kept the market buoyant.

For fund managers like us it was indeed a challenging year but the beauty of our “CGM” model is the fact that it enables investors to lose less in falling years and we have done exactly that this year and outperformed our benchmarks.

Now let’s look at some factors that will help us understand the undercurrents for 2019.

DII Flows to remain robust while FII outflows to reduce

Historically FII outflows have always been most influenced by rupee depreciation, widening CAD and higher crude prices. Stability of macro variables are the key for FII’s allocation to India among total EM allocation and going into 2019 we have witnessed some sanity in India’s macro variables as crude has fallen and is expected to remain depressed that will keep both the CAD and the rupee in check. Additionally a dovish commentary in US fed should also help ensure that the pace of FII outflows should moderate. In the meantime, Domestic flows have remained robust and only been looking up month after month which will create a strong foundation for the market.

Source: AMFI, Plus Delta Research

Fundamentals are improving and valuations are moderating

We entered 2018 with too much optimism and euphoric expectations have continued to drive valuations which recently received a jolt of reality from the market. This is the 6th consecutive year where earnings are in near single digit. Today we are in a situation where the valuation differential between PE of large cap companies and mid cap/small cap companies is at a six-year high i.e. mid cap companies are trading at a six-year-high discount to large cap companies. Out of the BSE 500, as many as 373 stocks are quoting below their levels at the beginning of the year. The market cap of India Inc., which was at Rs 151.73 lac crore at the beginning of the year, is now at Rs 143.30 lac crore. This is puts us at a very low base and with improving macro fundamentals the earnings can improve from here. When earnings improve valuations will be rationalized and can further retrace from the Current 26x to 18.5x which is the 15 year long term average for the NIFTY. So now earnings are improving, valuations are neutral and fundamentals are robust. This is an ideal situation for the market, if valuations drop further due to the election noise early next year; it will become a stock picking bonanza.

Source: NSE, Plus Delta Research

Crude – From tailwind to headwind to tailwind again

It took 14-15 months for crude to climb from $55 to $86 and the reverse from $85 to $55 happened in just 56 days. Across the year we did many discussions on “Traders Central” regarding crude oil and its trajectory. So the OPEC+ with Russia help have finally agreed to a 1.2 million bpd cut, but clearly that is not sufficient to stem the decline in crude, early reports suggest that crude will continue to remain in a surplus going into 2019 which suggests that crude prices should remain depressed going forward. The initial rise in crude prices impacted margins of Consumer/Auto/Cement in 1HFY19 and also raised the bogey of fuel price regulation for the OMCs, resulting in a sharp correction in the stock prices. Assuming full pass through a USD10/barrel reduction in the price of crude oil would push down retail petrol and diesel prices by ~INR4/liter and pushes down the CAD by ~USD11b, which is equivalent to 0.4% of the GDP. So structurally this is positive for the markets.

Source: Bloomberg

Elections – an overblown issue which market seldom takes seriously!

As stated in our earlier note “In the election noise don’t lose your poise!” (Read More at– We learned that the market has never had negative returns in an election year. We strongly believe that elections will only create a short term blip and will not greatly alter the secular trend of the bull market. The positive reaction after the state elections was a hint as to what the market is really discounting. Markets like stability and we believe if the current government is reelected then the market may post a knee jerk positive reaction. If we get a fractured mandate, the market will blink its eyes from a few months but eventually will revert back to its trend.

Aditya Iyer
Fund Manager – Plus Delta Portfolios

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