Sensex & Nifty are likely to trend higher in 2016 as many issues facing the market ease and abundant global liquidity finds its way into financial assets. The conditions for an equity rally are good, falling interest rates, low inflation expectations, cheap global liquidity and corporates being forced to compete in a disruptive market. However given the disruptive business environment, the winners will win big and losers will lose big. Hence the right portfolio is extremely important for returns or straddling the index will provide the cushion for disruption.
The Sensex & Nifty is closing calendar year 2015 on a flat to marginally negative note. The indices touched record highs at the beginning of the year but then dropped from highs and could not find strength to trend up from lower levels. Many issues hit the market from Fed rate hikes, Greece default, China Yuan devaluation, commodity price crash, rising trend of bad loans for domestic banks and lack of reforms by the government.
The fact that despite the odds, markets did not really fall sharply suggests that there is enough liquidity and appetite amongst investors for equities. FII’s were net sellers of equities in the April-December 2015 period and that selling was absorbed by domestic investors who pumped in around Rs 400 billion into mutual funds.
What lies ahead in 2016 for equities?
On the positive side, RBI has cut interest rates by 125bps in calendar year 2015 even as inflation expectations are being anchored at levels of 5% to 6%. Falling interest rates and stable inflation expectations encourage both investments and consumption and trends in the IIP (Index of Industrial Production) suggest that both are slowly picking up. Global liquidity is still cheap and easy despite Fed Rate Hike. Read our Fixed Income Strategy Note for 2016 for analysis on interest rates, inflation, economy, bank bad loans and global liquidity.
On the negative side are weak global economic growth, China hard landing, lack of domestic reforms and global security concerns. IMF downgraded global economic growth twice this year as China lowered growth forecasts to two decade lows. Commodity prices collapsed on weak China growth leading to recessionary conditions in many economies. Read our 2016 Commodity Outlook report for global growth concerns, China slowdown and commodity price collapse. The tensions in Syria and Iraq and feeding into the world with terrorist attacks on Paris and this could hurt economic sentiments as well.
The Indian government, of which a lot was expected, has really not delivered and key tax reforms such as GST have still not been implemented. Union budget for fiscal 2016-17 to be presented in parliament in February 2016 will be crucial for the government to show its commitment to reforms.
Bad loans are hurting Indian Banks with rising provisions. Credit growth has slowed to below 10% levels hurting both investment and consumption growth.
The negatives have to be overridden by positives in 2016 for equity markets to move up, which is probable given that consolidation in markets in 2015 have priced in the negatives. Unless there is a collapse in global growth with China landing hard, the negatives are not likely to come to the fore.
The year 2014 saw the return of optimism in the markets about the overall economy and the year 2015 saw a broader correction where economic growth did not materialise significantly as expectations had built up due a stable Government at the Centre. Macroeconomic factors have become favourable to some extent for the Indian economy in the year 2015 and the coming years would see growth trickling down to micro economic levels albeit at a slower pace as compared to that anticipated earlier.
Given that valuations are high in the current scenario as compared to the expected growth for most of the stocks, sector specific developments would drive returns in the year ahead.
Will the Equity indices deliver any returns in the year 2016?
The Sensex and Nifty have declined 6% and 4.85% respectively in the last one year. Will the sectors that delivered higher returns in the year 2014 be able to recover in the year 2016 after correction in the year 2015? We take a look at the sectors and look at their performance in the year 2015 and figure out what to expect from them in the year 2016.
The S&P BSE Consumer Durables Index has delivered 102.05% and 27.8% returns in the last five years and one year respectively and is the best performing index in the last one year. The S&P BSE Healthcare has delivered 156.58% and 15.13% return in last five years and one-year period respectively and is the best performing index in the last 5-year time period. Healthcare is followed by FMCG, Consumer Durables, Auto, IT and Bankex indices with a return of 120%, 102%, 80.89% and 64.96% returns in the last 5 years respectively. In the last one year the S&P BSE Consumer Durables has given a return of 27.8% followed by Healthcare at 15.13% and IT at 5.17%. S&P Auto, Bankex, FMCG, Realty, Metal, Power and Oil and Gas have declined in the last one year.
Some of the key sector performance in the last year and the expected outlook in the next one year is discussed below.
The S&P BSE Auto Index declined 2% in the last one year and rose 81% since December 2010.
The Indian automotive industry had struggled to show growth in the few years till 2014 but did show sustained recovery in the year 2015 due to fall in interest rates coupled with five-year low crude oil prices. The year 2015 saw improvement in the sales of companies especially in the Passenger Car and Medium and Heavy Commercial Vehicle segments. Medium and Heavy Commercial Vehicles led the industry this year with a 31.38% growth followed by Passenger Cars at 11.37% between April and November 2015. Sales in the Three Wheeler segment fell compared to last year and Two wheeler registered a marginal increase of 1.69% primarily due to Scooters.
The sales of Passenger Vehicles grew by 8.87 % in April-November 2015 over the same period last year. Within the Passenger Vehicles segment, Passenger Cars, Utility Vehicles and Passenger Vans grew by 11.37%, 3.05% and 1.12% respectively in April-November 2015 over the same period last year. The overall Commercial Vehicles segment registered a growth of 8.08% in April-November 2015 as compared to same period last year. Medium & Heavy Commercial Vehicles (M&HCVs) grew by 31.38% and Light Commercial Vehicles declined by 4.56%. Three Wheelers sales declined by 6.6% in April-November 2015 over the same period last year. Passenger Carriers and Goods Carriers declined by 6.58% and 6.7% respectively in April-November 2015 over April-November 2014. Two Wheelers sales registered marginal growth of 1.69% in April-November 2015 over April-November 2014. Within the Two Wheelers segment, Scooters grew by 12.44% and Motors and Mopeds declined 2.1% and 5.37% respectively in April-November 2015 over the same period last year.
In April-November 2015, overall automobile exports grew by 2.61% over the same period last year. Passenger Vehicles, Commercial Vehicles, Three Wheelers and Two Wheelers grew by 4.3%, 15.22%, 10.46% and 0.52% respectively during April-November 2015 over the same period last year.
In a scenario of lower diesel and petrol prices coupled with expected rate cuts by the RBI in the year 2016 the Automobile industry would grow at a pace that is either lower or equal to the growth rate seen in the current scenario. The Auto Ancillary industry that thrives on the growth of the Original Equipment Manufacturers (OEMs) would also grow at a moderate pace equivalent to that in the current scenario. The growth is expected to be moderate because the Commercial Vehicle segment growth depends predominantly on the borrowing costs for the owners and RBI is not expected to drastically cut rates in the year 2016.
Rising incomes coupled with higher disposable income did marginally accelerate growth particularly for the Passenger Car Segment in the year 2015. Growth in Two Wheelers especially in the Scooter category would continue to remain moderate for the year 2016 due to ease of use and convenience for drivers along with a relatively lower base compared to motorcycles. Rural segment growth is expected to be subdued for two wheelers due to lower than average monsoon in the calendar year 2015.
The major concern for the Automobile Industry remains the recent ban on the diesel vehicles below the 2000 cubic capacity in the National Capital Region. Rise in the pollution levels has led to the temporary ban on these Diesel Vehicles. Further, a pollution tax will be also imposed on engine capacities below 2000 cc for the region. The likely implementation of the ban in other areas of India now is an expected risk to the industry.
Oil and Gas Industry
The S&P Oil and Gas Index declined 5.76% and 11.36% in a one and 5 year time period respectively.
After the key developments for the oil and gas space in the year 2014 there were no significant policy decisions taken by the Government in the year 2015. Crude Oil prices in the international markets fell 46% from USD 67 per barrel to USD 36 per barrel in the year 2015. The year 2014 had already seen a fall of 50% from USD 116 per barrel to USD 57 per barrel for Brent Crude. Tepid demand along with rising supply of oil primarily from OPEC and US is expected to keep the price at lower levels for the year 2016. There is even a stark possibility of crude oil prices reaching lower levels than the current USD 36 per barrel due to demand supply dynamics.
The Gross Refining Margins and the Net Refining Margins for the oil industry tend to decline with the decline in the price of Crude Oil. Volumes are expected to show strong growth on the basis of decline in the prices of petroleum products viz. Petrol, Diesel, Aviation Turbine Fuel and other distillates.
The downstream companies are expected to continue reporting profitability but margins are not expected to rise significantly. Refiners have shown improvement in profitability and margins in the year 2015 already.
The government had increased the price of gas to USD 5.61 per million metric British thermal units (mmbtu) in the year 2014 but the prices have declined to levels of USD 4.24 per mmbtu in the year 2015. The volumes for gas distribution companies are expected to rise on the decision taken by the Supreme Court for the National Capital Region on pollution concerns. Decrease in Gas prices would marginally put pressure on the profitability and margins for gas distribution companies in the year ahead but also lead to rise in overall volumes that they would sell.
The S&P BSE Information Technology Index rose 5.17% and 64.96% in a one and 5 year time period respectively.
India is one of the fastest-growing IT services markets in the world. It is also the world’s largest sourcing destination accounting for approximately 52% of the USD 124-130 billion market. The country’s cost competitiveness in providing IT services continues to be its USP in the global sourcing market.
The Indian IT industry grew by around 13% in the year 2015. This is because it continues to attract more projects as foreign companies in the US and Europe outsource their IT needs to Indian companies. Companies continue to remain optimistic about the near future. This is because of the recovery in the US economy. The Indian IT industry is expected to add revenues of USD 13-14 billion to the existing revenues by FY15 according to National Association of Software and Services Companies (NASSCOM).
Margins would continue to remain under pressure for the IT companies as competition is expected to remain tough in the industry in the year 2016. Management of foreign exchange losses was a worry for most of the companies in the past but profitability has improved due to depreciation of the INR against the USD.
Given positive developments in the political scenario in Indian the INR is expected to remain stable in the face of broad strength in the USD as the US economy continues to show improvement on the macroeconomic front.
Enterprise Digital Transformation presents a good opportunity for the IT industry in the near future. Our study reveals that enterprises will need to spend USD 70 Billion in 2015 in order to stay competitive against new emerging digital native organizations. This spend is expected to grow at a CAGR of 26% to reach USD 230 billion by 2020. Of this, enterprises in North America are expected to take a lead with a spend of USD 26 billion, which is expected to reach USD 73 billion by 2020.
Increase in spending from the BFSI and Healthcare segments is expected to continue as the US economy shows further recovery in growth of its GDP. Europe would continue to struggle in terms of GDP growth in the year 2015 due to which revenue contribution from the continent for the IT companies would show only moderate growth.
The S&P BSE Bankex declined 9.48% in the last one year and rose 48.2% since December 2010.
The year 2015 was a muted year for the banking sector as banks grappled with rising NPAs. Overall Indian banking sector asset quality has seen deterioration with gross non-performing advances for the banking system trending sharply upwards, it was at 5.1% as on 30th September 2015,2.77% bps increase since 2008-09, PSU banks had the highest level of stressed assets at 14.1%, Private banks 4.6% and Foreign banks 3.4%. Though private sector banks have comparatively less NPAs they are not showing any significant improvement in lowering NPAs. The sharp increase in the share of NPA of large borrowers to the total NPAs from 78.2% in March 2015 to 87.4 % in September 2015 is a major concern to the banking sector and Indian economy.
Five sectors mining, iron & steel, aviation, textiles and infrastructure have contributed the most to the non-performing assets (NPA) of banks. Public Sector Banks have maximum exposure to these five sectors. The government proposes to spend Rs.700 billion of tax payers money in recapitalization of PSU banks. PSU banks have been reeling under bad loans caused by poor credit analysis and by weakness in the domestic and global economy post the 2008 global financial crisis.
RBI has cut the benchmark repo rate by 125 bps in the year 2015 but lending activity could not take off. Also banks credit growth was subdued below 10% showing weakness in economy.
India’s Government banks are undercapitalised. RBI financial stability report mentions Indian banks will require an additional capital of Rs.5 trillion to implement the Basel III norms, including Rs.3.25 trillion as non-equity capital and Rs.1.75 trillion in the form of equity capital in the next five years. Plans have been approved to raise about Rs 1.6 trillion (USD 25.76 billion) by selling some stake in state-run banks by 2019.This move would give sound corporate governance and make the PSU Banks efficient giving a positive outlook for longer term.
2016 would be subdued for the banking sector as it needs to solve the NPA problem, consolidate provisions on priority basis and which will take at least 12-15 months to see its primary results. The UDAY (Ujwal DISCOM Assurance Yojana) with an objective of financial turnaround of state owned power distribution companies scheme passed by the central government will help banks who have exposure to these loans to reduce NPA levels to some extent in the longer term.
To maximize financial inclusion RBI distributed small finance bank and payment bank license in the year 2015. Banking sector is likely to witness stiff competition in the time to come, from players that have been licensed to deal as payment banks.
The S&P BSE Healthcare Index rose 15.13% and 156.58% in a one and 5 year time period respectively.
Healthcare has become one of India’s largest sectors – both in terms of revenue and employment. The industry comprises hospitals, medical devices, clinical trials, outsourcing, telemedicine, medical tourism, health insurance and medical equipment. The Indian healthcare industry is growing at a tremendous pace due to its strengthening coverage, services and increasing expenditure by public as well private players.
The Indian healthcare delivery system is categorised into two major components – public and private. The Government i.e. public healthcare system comprises limited secondary and tertiary care institutions in key cities and focuses on providing basic healthcare facilities in the form of primary healthcare centers (PHCs) in rural areas. The private sector provides majority of secondary, tertiary and quaternary care institutions with a major concentration in metros, tier I and tier II cities.
Indian pharma companies would continue to experience strong growth in the U.S. as the overall growth prospects remain strong despite challenges in form of increased scrutiny by US FDA. The industry is expected to take advantage of the patent expiration wave in the US, steady demand from emerging markets and favourable foreign exchange scenario. Most of the leading players are now generating a sizeable proportion of their revenues from international markets, especially U.S.
The Indian healthcare industry is projected to continue its rapid expansion, with an estimated market value of USD 280 billion by 2020. The sector is poised to grow to USD 160 billion by the year 2017.
In an expected scenario of only marginal reduction in the interest rates in the year 2016 along with inflationary concerns due to drought in the year 2015 and fiscal challenges for the Government, most of the sectors in our 2016 theme would continue to perform and deliver moderate returns. There are some sectors that are expected to outperform the others in this scenario. IT and Healthcare would deliver growth on the expected lines due to positive economic developments in the US economy amidst reduced uncertainty about the interest rate hikes. Automobile sector has shown sustained recovery in the last one year and segments such as Medium and Heavy Commercial Vehicle and Passenger Cars would continue to deliver growth higher than other segments. Fall in crude oil and gas prices would have a significant effect in terms of volume and Sales growth for the Oil and Gas sector. A fall in the crude oil and gas price would improve the volume of products sold. Oil Marketing companies would continue to report profitability on the basis of deregulation of petrol and diesel prices in the year 2014.