Summary

• Indian equities continued to move higher over January with the large cap outperforming mid and small cap indices. Worries over the annual budget on 1 February prompted domestic investors into some profit taking in the mid and small cap stocks, whilst some decent results and continued foreign flow aided the larger counters.
• The latest quarterly result season has started well, with numbers exceeding expectations so far. If the results continue to beat analysts’ forecasts this will likely be the best quarter for some time.
• On 1 February the government delivered its annual budget. Worries over fiscal profligacy and populism were largely allayed, although the focus on rural India indicates the mind of government is turning to the 2019 national election. The biggest announcement was an ambitious healthcare insurance scheme covering 500 million beneficiaries.

Fund activity

We undertook very little trading activity in January, with no new stocks added or existing positions sold. We used some market weakness to add to Godrej Agrovet and booked some profit in both Ashoka Buildcon and Hindalco Industries.

Over the last few years Indian markets have witnessed a significant divergence between the market returns generated by large cap stocks versus mid and small cap stocks. Globally the trend has been for larger stocks to outperform (for example, the performance of the US and Chinese e-commerce giants), albeit most of the outperformance has come from a fairly narrow number of sectors. India by contrast has seen significant outperformance from the smaller companies. A number of reasons have caused this, the principal being that this is the part of the market favoured by domestic investors.

Domestic investors more recently have been the predominant source of market liquidity, as a result of structural reforms and a demographic changing of the guard. The demonetisation event back in November 2016 (over 90% of the cash in circulation was withdrawn overnight) sent a clear message that holding cash was now risky. In addition, technological changes combined with a young population who are very technology literate have made accessing markets easier than ever. The net result is a structural increase in domestic participation in India’s financial markets that is here to stay.

In spite of this, January was a rare month where larger cap stocks significantly outperformed. While we do not think that this is a harbinger of a change in market dynamics, domestic investor nervousness around India’s annual budget encouraged some profit taking in the mid and smaller cap stocks. This impacted January’s fund returns, in spite of some excellent results from portfolio holdings.

By the end of January nearly half of the Nifty companies reported results with the profit after tax (PAT) growth for the 24 companies who have reported standing at 35% YoY. Of the 24 companies, 15 reported PAT higher than their estimates, pointing to a robust earnings season so far.

Outlook

Since markets registered new all-time highs on 29 January, we have seen a sell-off led by global weakness and profit booking by investors following the introduction of Long Term Capital Gains tax in Union Budget FY19. The budget focused on rural growth, infrastructure push, employment creation, MSME (Micro, Small and Medium Enterprises) support and social welfare, which was in line with expectations and is expected to support lower income groups in general. While the budget clearly indicates the mind of government is turning to the national election in 2019, some had feared a much more populist budget than that delivered.

We remain convinced that many of the impediments to a more robust economic recovery are now behind us, and the better than expected earnings season that we are currently going through is an early indicator that the economy is accelerating. We welcome signs that volatility is on the rise both globally and in India as we will be using any stock price weakness to add to what we believe are some very attractive companies.