After a strong rally in 2017, what is your outlook for global stock markets?
After the strong gains in 2017, we are still positive on the outlook for global stock markets in 2018 because of strong earnings growth and solid, synchronized global GDP growth.
Currently, the earnings expectations are not very high. For example, in the US, earnings are expected to grow around 10% in 2018. However, the US government passed the tax cuts, including corporate tax cuts in late December, which will lead to strong earnings growth in the US. The tax cut will also help US corporates increase capital expenditure which should boost GDP growth, which in turn will help other countries grow and have stronger earnings.
Second, global growth is solid and we should expect further improvement. For instance, GDP growth in US was 2.3% in 2017 and is expected to grow around 3% in 2018. Further, Europe and Japan are also expected to grow at a solid pace. Among emerging markets, China’s growth is expected to remain stable, around 6.5%, while India’s GDP growth is likely to exceed 7% in 2018.
2017 has been the year of low volatility across the globe. Also, most of the developed markets have not seen a sharp decline over the last couple of years. What is your reading of this situation?
I think one of the reasons for this low volatility and no correction is ‘buying on a dip mentality’. Last year, there were a few instances where specific stocks fell sharply but investors who were waiting for the correction to happen, have invested heavily leading the markets to rally.
For most major economies and markets, 2017 was a great year in spite of the retreat from globalisation, Brexit, North Korea, Middle East problems, etc. Why did the market overlook these developments?
Let us take each one individually. On Brexit, there was a big correction in the global markets after the Brexit vote in June 2016. However, market participants believe that there could be some agreement between the European Union and Britain resulting in a recovery in the markets.
Tension between the US and North Korea has been a lot of talk, heated talk, but no action. The worst case scenario is that there could be an armed conflict, but we think it is very unlikely. In our view, both these countries are likely go to the brink, but pull back.
The Middle East problem persists. However, it has not escalated. Markets have factored in this issue.
The key reason why markets have discounted these events is the upside surprise on earnings growth. Markets expected 8-10% growth in earnings in 2017; however, earnings grew by 18% in US. Similarly, many other global markets, such as Japan, Europe, China and India, are growing. I can say that everybody in the world is growing.
Another key factor that helped the markets rally in 2017 was the expectation of corporate tax cut in US, which did happen in late 2017.
In addition, globally, inflation is under control and central banks have not raised rates. All these factors have offset events like Brexit and Korea.
What are the downside risks that you think are being overlooked currently?
Clearly, valuations have become expensive globally. Another factor that the markets have overlooked is rising inflation. This may lead central banks such as US Federal Reserve (Fed), European Central Bank (ECB) and Bank of England (BoE) to raise rates more aggressively than what the markets are currently expecting.
Further, geopolitical tension may escalate, for example in Korea.
Finally, investigation of Russian interference in US elections may also affect the markets.
As we get into 2018, there is great optimism all around. Is this optimism justified?
The basis of optimism is strong earnings growth. In my view, we are likely to see strong earnings growth in 2018. Current market expectations for 2018 earnings do not incorporate the effect of US tax cuts. Now with the lower US corporate tax rate (which was lowered from 35% to 21%), we can expect higher profits and stronger earnings in 2018. Further global GDP growth remains solid, which should also boost profits. Finally, rate hikes by developed central banks are likely to be gradual. Hence, I think the optimism is justified
What do you see as some of the biggest investment opportunities in 2018?
We are bullish on financials, industrials, materials and IT sectors.
While financials will benefit from lower tax rates and rising bond yields, infrastructure push will drive industrials and materials sectors.
Similarly, innovation will push demand for IT stocks.
Most of the developed countries will be eyeing rate hikes in 2018. How do you see it impacting the flows to emerging countries such as India?
This year, we will probably see the US Fed raising rates and ECB tapering quantitative easing. However, the policy normalisation is likely to be gradual. Fund flows are likely to continue as investors are looking for growth opportunity in emerging markets like India. Growth themes such as infrastructure themes in India will attract capital flows. Though there may be a little bit of a pullback, I do not see a complete reversal of fund flows from developed markets to India.
Where does India stand vis-à-vis other markets?
We have been very positive on India in the past. Though the long term bull story for India is still intact, we are concerned about the short term prospects of the market.
There are several reasons for the short-term caution. One of the reasons is valuations. Currently, the valuations of Indian markets are very high compared to other emerging markets. While the valuations of large cap stocks is a little above long-term average, valuations of mid and small cap companies are very high. Second, earnings growth has disappointed thus far. We would like to see revival in earnings.
Another big risk for India is rising oil prices. If oil prices hover around $70 a barrel, inflation will increase. In India, oil prices elasticity of Inflation is very high, i.e., big impact of oil prices on inflation. Higher oil prices could lead to higher inflation forcing the RBI to raise rates. Further, the government may find difficult to achieve its fiscal deficit targets with high oil prices.
Hence, we are cautious on India in the near-term and have reduced our overweight in India.
However, in the long term, we remain positive due to healthy growth prospects, continued reforms, and increasing penetration of financial assets in retail portfolios.