This is an extract from a post that appeared in the India Markets Observer 2018, an online publication that brings together experts who discuss these challenges in the fund industry and investing insights and various perspectives.
Last year, investors rode the “wall of worry” where real or imagined problems were logically presented or put up in fear. Eventually, investors wished they had put more money to work in risk assets.
It was a year of robust returns for global investors across a variety of asset classes. In safety asset classes, like global government bonds, we saw positive single-digit returns and in riskier parts of fixed income, total returns have been just under 10%. Further out on the risk spectrum, global equities delivered over 15% and emerging markets above 30% in U.S. dollar terms.
The Indian equity market performed extremely well clocking 29.5% in CY2017. With a strong rupee the returns in fixed income for global investors in Indian bonds was nothing short of astonishing.
These are impressive annual returns and, in hindsight, was a great phase to be an asset allocator. When we look back over the last few years, cumulative returns look pretty strong in selected parts of the opportunity set. Global equities, for example, returned an annualized 10%+ over the last 5 years.
Can the runaway returns of 2017 be repeated this year?
The expected sharp interest rate hikes in the U.S. did not materialize in 2017. Liquidity remained stable and growth began to show a synchronized uptick across major developed markets. In India inflation consolidated, domestic liquidity remained buoyant and interest rates saw a gradual fall but remained in a range for most part of the year.
Corporate earnings disappointed but the sentiment was balanced by announcements of major reform initiatives (bank recapitalization scheme, GST implementation). While valuation multiples expanded, the start of government investment in major projects led industrial companies and certain construction companies to record significant gains. The global materials price uptick also led certain material companies to perform well in 2017.
While liquidity remains benign, growth continues to be clocked at a healthy pace across major economies, and the U.S. Fed hikes remain cautious, there are some factors that can spoil the party this year.
* North Korea and the fresh turmoil in the Middle East may continue to be geopolitical irritants.
* The Gujarat elections set the tone for much contemplation of the real message from the people in the home state of the Prime Minister. This election result was seen to be a barometer of public reaction to the reform process of the government. The subsequent acquittal of the major accused in the 2G telecom spectrum scam also made some interesting side stories to the political debate. The market remained indifferent to both events and they have largely fallen in “neutral” territory without shaping any clear direction either to public opinion or to the popularity of the ruling party.
* Interest rates in India could be range bound with short spurts of easing on the back of news flow and vice versa. We do not expect them to rise substantially in the near future, nor do we anticipate a steep fall.
* Earnings growth in India is likely to remain strong. Valuations remain in higher than historical range vis-à-vis earnings. The expected increase in RoE’s following margin expansion and lower rates of interest signal a stable environment in spite of the ostensible expensive multiple on earnings. P/B multiples however are well within the long-term averages and the market may be pricing in a much stronger recovery than in the estimates so far.
* We expect market volatility to be driven by political and geopolitical events as and when they occur but do not expect fundamentals to deteriorate very significantly. Whether this leads to higher market levels is a moot point given current market valuations.
We conclude….
- Earnings recovery will bring earnings multiples down, though not in line with long term averages
- Market returns will stay positive though will not touch the levels seen in 2017
- Interest rates will remain in a range
- Increasing domestic and foreign participation may provide opportunities for higher than average multiples to sustain and as a result, given a penchant for volatility investors could choose to remain invested in the equity asset class as it may yet provide the highest returns across available asset classes this year
- Intermediate bonds are likely to remain a fairly attractive asset class on a relative basis.
Data source: Bloomberg & HSBC Global Asset Management
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