#39;Expect recovery in auto sector but may not reach all-time highs of 2018 anytime soon#39;
We expect auto stocks to recover from current levels. However, achieving all-time highs of 2018 is unlikely anytime soon, Jyoti Roy, Deputy Vice President Equity Research, Angel Broking Ltd, said in an interview with Moneycontrol’s Kshitij Anand.
Q) According to a survey by a global investment bank, investors expect a global recession in the next 12 months, the highest since 2011. Do you think fears of a global recession are looming large on the US and India may not be able to escape? Should investors be worried?
A) The US Fed had also aggressively raised rates in 2018 and has been winding down its balance sheet at a rather brisk pace from $ 4.45 trillion at the end of 2017 to $ 3.78 billion by July 2019 end.
The ECB and the BOJ have also refrained from increasing their balance sheet size since the first quarter of 2018.
As a result, cumulative balance sheet sizes of the three large central banks peaked at $ 14.9 trillion in Q1 2018 and have come off to $ 14.3 trillion by July 2019 end.
The current economic expansion in the USA has been the longest in history and is in its 10th year now. A slowdown seems inevitable at this point of time especially in the backdrop of the ongoing US-China trade war which seems unlikely to abate anytime soon.
While it may be too early to call for a recession we believe that global economic growth is going to slow down over the next few quarters.
Recent inversion of the US yield curve has spooked investors with US bond yields falling sharply in August after Trump’s latest proposal to impose tariffs of 10 percent on additional Chinese goods worth about $ 300 billion.
However, the tariffs which were supposed to come into effect from September 1, have now been deferred to December for some goods while other goods like mobiles and consumer goods have been exempted from the tariffs.
We believe that the recent fall in bond yields have been a knee jerk reaction to the latest escalation in trade tensions between the US and China. While global growth is slowing down led by China, US growth continues to be relatively strong with the GDP growing at 2.1 percent in the second quarter of 2019, as per advance estimates.
High-frequency data points to a mixed picture as manufacturing PMI and US class 8 truck orders are pointing to slowdown in the manufacturing sector.
However, recent inversion of the yield curve is a cause of worry for the markets. With the US Fed’s preferred measure of inflation, the PCE deflator running at 1.5 percent, there is some elbow room available with the Fed to cut rates.
With the US Fed indicating that they would stop shrinking their balance sheet from August 2019 cumulative central balance sheets would again start expanding for the first time since September 2018 which should provide some sort of stimulus to the global economy.
We feel that markets would continue to look at the high-frequency data points for some more time before coming to any conclusion as it is still too early to say whether the US economy is going to slip into a recession.
If the inverted yield curve persists for the next couple of quarters then the chances of a recession would go up. However, if the US economy continues to remain relatively strong then bond yields could rise again, which coupled with expected rate cuts from the US Fed, could lead to a reversal of the inversion.
Q) The inversion of US Yield curve triggered risk-off sentiment among the global investor community. How are things looking for Indian markets?
A) We believe that the fall in Indian equities is on account of domestic issues like the NBFC crisis and hike in surcharge on individuals/trusts earning more than Rs 2 crore.
The NBFC crisis which started with the fall of IL&FS soon spread to other some other systematically important financial institutions which has hurt growth.
This coupled with a sharp cutback in government expenditure due to revenue shortfall and the 2019 general elections led to a sharp slowdown which as reflected in the Q1FY20 GDP numbers which came in at 5.8 percent.
Growth is expected to remain sluggish in Q2 as well given that transmission of the 110bps rate cut by the RBI is yet to happen.
We expect that Indian equities will remain range-bound with a downward bias in the near future as we expect growth to remain muted for the next couple of quarters.
Q) How did India Inc fare in the June quarter earnings? How is September quarter likely to pan out for D-Street?
A) The general slowdown in the economy was reflected in the June quarter numbers as earnings growth continued to slow down.
While the general elections did play spoilsport in Q1, management commentary indicated that growth continued to slow down post-elections despite increased government spending.
For the banking sector, profitability continued to remain under pressure due to higher provisions on account of non-performing assets. Earlier, it was corporate accounts which were driving NPA growth.
However, the slowdown has now started taking a toll on the retail segment where there were some signs of stress. However, it is too early to call for a spike in NPA’s from the retail segment as the transmission of rate cuts are yet to happen.
We expect the September quarter earnings to be muted as economic growth is expected to remain muted in Q2.
We expect earnings to pick up only in the second half of FY20 especially the fourth quarter as the transmission of rate cuts along with increased government spending is expected to push up GDP growth. Numbers will also be helped to some extent by the low base of H2FY19.
Q) Top five outperformers and underperformers from the Q1 season and why?
A) Q1FY20 numbers were disappointing or at best in line with estimates as growth continued to slow down.
While individual stocks did report better than expected numbers, the overall earnings growth was very sluggish.
Among stock in our coverage, ICICI Bank, Infosys, KEI Industries and GMM Pfaudler reported better than expected set of numbers.
Q) FIIs have been pulling out money from Indian markets consistently since July while MF absorbed most of that selling. But, do you think the momentum will continue? More FII selling till December 2019?
A) FII selling in Indian markets has largely been on account of a hike in surcharge for super rich.
One of the inadvertent side effects of the hike was higher taxation for FPI’s registered as trusts in India which led to the FII selling in July.
Markets are expecting a carve-out by the government for FPI’s, which would exclude them from paying a higher surcharge. Any relief from for FPI’s would go along way in stemming the outflow of FPI money from India.
Q) Auto sector has been under pressure with more firms opting for shutdowns. Do you think this sector could produce wealth creators if someone buys the stocks at current levels with a time frame of 2-3 years?
A) The auto sector is going through a tough phase due to multiple factors like a slowdown in demand, increasing competitive intensity due to new entrants and cost pressures.
BS-VI implementation from April 2020 is another major hangover for the Industry.
In such a scenario we fell that the auto industry would remain under pressure at least till the first half of FY21. Of course, we expect some improvement in monthly sales numbers from the abysmally low numbers that we have witnessed in June and July.
Upcoming festive season coupled with expected pre-buying in diesel cars before the implementation of BS-VI norms would also help volumes in the second half of FY20. The low base of H2FY19 would also help companies post decent growth numbers in the second half of the year.
Increasing the competitive intensity and increasing cost pressures due to implementation of BS-VI norms would however result in normalized profit margins to settle at a lower level then what the Industry was used to.
While EV is not a major threat to the industry in the immediate future, markets will be cognizant of the fact that over the medium to long term industry dynamics could change.
We do expect a recovery in Auto company stock prices from current levels, but at the same time, we are of the view that that the all-time highs of 2018 are unlikely to be achieved anytime soon.
Q) D-Street eye stimulus measure from the govt to revive the economy. What could be those measures which could lift investor sentiment?
A) Given the current slowdown in tax collections, we believe that the recommendation of the Bimal Jalan committee report on August 23 is one of the most critical factors to watch out for.
Markets are expecting that the committee would recommend transfer of RBI’s surplus reserves over the next 3-5 years.
While the government was pushing for a one time transfer even a phased transfer would go a long way in helping the government to meet its spending goals without breaching the fiscal deficit target of 3.3 percent for FY20 by a wide margin.
The quantum and period over which the transfer would take place are subject to the recommendations of the committee which we will get to know in due course.
Markets are also expecting some relief for FPI’s from additional surcharge along with certain other measures like relaxation in LTCG on equities.
Once the recommendations of the Bimal Jalan committee report are made public the Government could also announce some tax reliefs for corporates as they would have clarity on additional resources available to them.
While it may not be possible for the Government to meet all the expectations of Industry and market participants addressing some of the key concerns like taxation on FPI’s and mobilization of additional resources to provide stimulus to the economy would go a long way in lifting investor sentiments.
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