The latest development of a sharp decline in China’s exports by 10 per cent in September, despite having taken measures such as devaluation of Yuan, indicates that the global recovery is in for a long haul. Moreover, a decline in global and domestic demand is already hurting the capital investment side of the Indian economy. This also means that the hopes of a near-term turnaround in capacity utilisation levels of India Inc and corporate investments in the economy is only going to get delayed.
A high manufacturing capacity in China with declining exports not only indicates the contraction in global absorption capacity but also has the potential to defer foreign direct investment under the government’s Make in India initiative as in such an evolving environment investors would prefer to postpone their investments till a time when they see stability and an uptick in global and domestic demand.
Though equity markets have generated strong returns (of over 20 per cent) for investors over the last eight months, experts feel that going forward investors may have to be more careful with their investment choices as the hopes of a broad-based recovery in the economy may still be few quarters away.
“We don’t see a broad-based recovery any time soon. While sectors driven by consumption and public spending are likely to do well, there are no signs of a recovery in industrial capex as of now,” said Harsha Upadhyaya, CIO-equities at Kotak Mahindra AMC.
Even though Reserve Bank of India has cut the repo rates by 175 basis points since January 2015, it has not led to any meaningful capital investment. Economists feel that rate cut alone cannot fuel investment as manufacturers are sitting on high unutilised capacities.
In the September fact sheet of Franklin Templeton AMC, CIO Anand Radhakrishnan acknowledges that private investment growth has not yet picked up despite the government’s efforts, higher public investment and encouraging jump in foreign direct investment. “Private capex remains on weak trend, partly due to weak external demand conditions. While the external demand could stabilise in the near to medium term, the meaningful recovery for private capex seems to be some time away given weak capacity utilisation, concentrated debt concerns in the industrial sector and stretched balance sheets of state-run banks,” he said.
While Upadhyaya avoided giving a timeline for expected revival of capex, he said: “One should not expect a sustained revival in capex as the capacity utilisation levels continue to remain around 75 per cent. Fresh capacity additions will not happen until capacity utilisations rise to levels of 85-90 per cent.”
In a scenario where fund managers and analysts are practicing caution on putting their bets on companies in sectors such as capital goods and metals, investors may go for investment into consumption oriented sectors. In fact, both good monsoons (that has resulted into an increase in total sown area) and implementation of 7th Pay Commission recommendations are expected to lift the rural and urban spending and thereby strengthen private consumption.
Pankaj Pandey, head of research at ICICIdirect.com said that even as there were some expectations of recovery in capital expenditure by companies over the last one year, the broad-based recovery is missing and it has only been in patches. He, however, said that consumption led sectors may witness growth. “We expect our consumption-related stock basket to see a top-line growth in high single digit and the bottom-line to grow by around 16 per cent,” he said.
Over the past year consumption indicators such as passenger vehicle sales, airline traffic and fuel consumption have shown an upward trend and they are playing out in favour of an uptick in private consumption. On the other hand while broader trend of capital expenditure is missing, Pandey said that capex is visible only in four areas — road construction, power generation, power distribution and railways. He added that in some of the sectors where capex is taking place, such as solar power, there are not enough listed firms.
A recent report of Credit Suisse pointed out that India is among the four most overvalued markets along with Indonesia, the Philippines and Malaysia (on price to book value vs return on equity valuation model). Even on the Price/Earnings to Growth valuation model, the research house said that if the error in Earnings per share estimation (much higher than actuals) is taken into account then Indian markets are overvalued. Even as the valuation concerns remain, Pandey said that it is the relatively higher growth rate expectations of Indian economy that will attract investors to India. “Valuation concern is secondary at this time as the world is taking a call on relative growth and India is expected to do better than many others,” he said.
In fact, foreign portfolio investors have been strong investors in the Indian markets and they have invested a net of Rs 52,318 crore in Indian equities in the calendar 2016.
Even the Franklin Templeton report pointed that while Indian markets are trading at expensive levels, investment opportunities are available in firms across certain sectors. “We believe that upside potential due to the re-rating appears limited as valuations across market-cap segments are now above their long-period averages. Nevertheless investing in firms (which may not be the momentum players) having attractive valuations along with the potential of sustainable earnings growth would be the key for generating alpha over the long term,” said Radhakrishnan.