India Startegy

Edelweiss Investment Research INDIASTRATEGYINDIA STRATEGY: MACRO HEADWINDS AMIDST EARNINGS RECOVERY Sahil Kapoor Shobana Krishnan May 2018 Chief Market Strategist Economist [email protected] [email protected]

OverviewWhere are we in the Cycle?● Stock Markets, Earnings and Economic Cycles all have their own respective Cycles. Stock Market Cycles precedes earnings. Earnings Precedes economic cycles.● Evidences from Global and Indian MarketsIndian Markets● Our Economic cycle suggests we are in the beginning of an economic recovery.● High Frequency Indicators too suggest a nascent recovery is gaining more ground● However signals from- a) Bond Markets (Rising Yields) and Currency Markets b) Valuations-P/E, P/B c) Relationship between global and Indian Markets d) Cyclical versus Defensives Ratio● Indicate thick headwinds for Indian markets in the short term.● If global economic recovery is aging what will drive Indian markets?Global Markets● Are the global markets in the late end of a mature cycle?● Signals from- a. Bond Markets ( Flattening of yields at low interest rates) b. Bond, Commodities and Stock Markets all are Rising c. Valuations- P/E, P/B d. EM currencies outpacing Dollar● So has the global market already peaked in January? 2

Headwinds Ahead, But Earnings SupportiveThe cyclical nature of the economy and stock markets works in varying degrees in each economy. Even after a wellentrenched trend of global trade and globalization the economic cycle of nation states still remain isolated. Globaleconomic strength and weakness accentuates or depresses these cycles.● US appears to be in an aging economic cycle. While almost every economic data set appears robust the age of economic expansion, behavior of the bond market and a few leading indicators suggest that the pace of economic expansion may slowdown.● India seems to be still in a recovery mode. In the last few months economic data like manufacturing, vehicle sales and investments seems to be strengthening the recovery is till patchy.● A thick headwind is present for Indian economy which is likely to keep the recent economic recovery under check.  Trade and fiscal positions for India was improving for India over the last 3 years. It has now begun to deteriorate. Although not alarming but its effect are visible in weakening Indian Rupee and higher borrowing costs.  Strong foreign flows have been a bedrock of each phase of strong economic and stock market cycle in India. These flows have either come in the form of FDI or FPI equity or FPI debt in each of the previous cycle. These flows appear to have tapered and may continue to remain shallow in the short term.  Approaching elections, elevated bond yields, EM currency weakness and deteriorating current account is likely to keep Indian markets under check. But support from earnings in FY19 will be supportive.  Nifty (CMP 10,900) FY18 EPS is likely to see a growth of 8% and close at INR 485. An earning growth of nearly 15% in FY19 would take Nifty EPS to 560. Near term stress may reappear on stock indices and sectors due to macro headwinds. 2018 could remain a year of earnings recovery but PE de-rating.  At 17.5X Nifty is likely to trade near the 10,000 level in the short term and as we approach FY19 end. The markets are likely to trade near 11,500 based on 17.5X FY20 EPS of 660 by June’19 3

India’s Business Cycle Still Weak But Recovering 4

% y-o-yIndia’s Business Cycle: In Recovery Mode, But Still Under Water India’s Seasonally Adjusted Cyclical GDP* 3.8 1.8 -0.2 -2.2 -4.2 -6.2 q1 1997 q3 1997 q1 1998 q3 1998 q1 1999 q3 1999 q1 2000 q3 2000 q1 2001 q3 2001 q1 2002 q3 2002 q1 2003 q3 2003 q1 2004 q3 2004 q1 2005 q3 2005 q1 2006 q3 2006 q1 2007 q3 2007 q1 2008 q3 2008 q1 2009 q3 2009 q1 2010 q3 2010 q1 2011 q3 2011 q1 2012 q3 2012 q1 2013 q3 2013 q1 2014 q3 2014 q1 2015 q3 2015 q1 2016 q3 2016 q1 2017 q3 2017 Source: CMIE, Edelweiss investment Research● From 1997, there have been 4 episodes of Recession (adjusted), longest being from Q1 2000 to Q2 2002 (5 quarters) followed by longest period of expansion from Q3 2003 to Q3 2007 ( 17 quarters).● The last cycle of recession started from Q2 2016 till Q2 2017. We are still in early stages of economic recovery.*Seasonally adjusted series using ARIMA-12,HP Filter and NBER dating algorithm using the spliced Real GDP series available in CMIE. Refer to annexure for cycles interpretation 5

India Remains A Compelling Story As Peers Struggle 6

India: One Of the Major Contributor To World Growth India and China to Contribute 45% of World’s Growth in 2018 0.6 Advanced 3.9 Economies to add only 0.4 25% to World Growth 1.1 Other Emerging Economies to contribute another 25% 0.61.2 About 45% of World Growth to come from India and ChinaChina India Emerging Ex China, india US Advanced Ex US World Source: IMF WEO Database, Edelweiss investment Research● World Output is expected to grow at 3.9% (y-o-y) in 2018, strongest growth projection since 2011.● Advanced Economies were growing rapidly since 2014, while Ems were struggling. The phase of strong EMs growth is expected to return, with EMs contributing 75% to World Growth.China and India are the most influential contributor to World’s Output growth, reiterating that India’s economic 7recovery is gaining traction and remains a compelling long term story

Emerging Market Scorecard: India Less Vulnerable, For Now South Thailand Turkey* Taiwan* South Mexico India Saudi Indonesia Argentina China Brazil Russia Africa* Korea* ArabiaProtectionism Vulnerability 25.6% 51.9% 18.5% 54.8% 36.5% 35.6% 11.3% 32.2% 16.6% 9.1% 19.0% 10.6% 23.3%(Exports as % of GDP, 2017) Rates Vulnerability -2.3% 10.8% -4.6% 13.5% 5.6% -1.8% -1.2% -2.5% -1.5% -3.6% 1.3% -0.7% 2.2%(Current Account Balance as % of GDP, 2017) Oil Vulnerability -3.0% -3.5% -1.6% -3.1% -3.1 0.9% -2.6% 20.9% -1.3% -0.2% -1.2% -0.4% 10.0%(Estimated Net Oil Production as % of GDP, 2016)Vulnerability Ranking(1= Most Vulnerable) 1 2 3 3 5 6 7 8 9 10 11 12 13 Source: Bloomberg Economics, BP Statistical Review of World Energy, International Monetary Fund, World Bank; *Only oil consumption data is available for these economies 8

India’s Macro Stable Compared To 2013, But Deteriorating Thailand 1.0 0.0General Government Balance (% GDP) Indonesia -1.0 China Thailand Brazil Indonesia China 8.0 10.0 12.0 -2.0 -3.0 -4.0 South Africa South Africa -5.0 India India -6.0 -7.0 -8.0 Brazil -9.0 -8.0 -6.0 -4.0 -2.0 0.0 2.0 4.0 6.0 Current Account (% GDP) 2013 2018● India has been following the path of fiscal consolidation, not withstanding slippage in last year.● Among the EMs, Brazil and China have witnessed deterioration both in terms of Current Account and Fiscal Balance. Thailand has improved the most followed by India and South Africa.India’s Current Account Balance and Fiscal Balance shows improvement as in comparison to the times of taper tantrum. Butthis improvement is coming under stress and EM environment become challenging 9