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Riding the Wall of Worry

May 2, 2017



  • The second round of French elections are likely welcome news for the markets with the strong emergence of pro EU centrist Emanuel Macron, taking on Marine Le Pen and favoured to win.
  • President Trump’s tax plan has raised concerns on ballooning deficits in the U.S., and there is a rising lack of clarity on the extent of revenue loss by the U.S. Government that would need to be offset by a rebound in economic growth.


  • Equities are being buoyed by earnings announcements, with many corporates positively surprising on bottom lines and demonstrating strong top-line progression.
  • Fixed income yields have rallied slightly in the last fortnight on fears of a potential forthcoming rate hike by the RBI, as CPI touched a five-month high, albeit under the 4% medium term target.


Global markets have been volatile recently, primarily because two major events. One is the crucial French elections and the other is President Donald Trump’s long overdue “corporate-friendly” tax proposal.

French Elections Have Markets Breathing a Sigh of Relief

The primaries of the French elections were broadly interpreted by markets as a positive outcome. Initially, the far-right nationalist Marine Le Pen had appeared to emerge as the strongest Presidential candidate. Since then, pro-EU centrist candidate Emanuel Macron has garnered momentum with convincing debate performances.

In the recently concluded first round, Macron amassed 24.01% votes vs. 21.3% for Le Pen. This has allayed fears of a Brexit-like fall-out on the French elections and a cloud over the future of the Euro zone. All eyes now focus on the second round to be held on 7-May-17 with markets pricing in a Macron win, evident particularly in the recent strength in the Euro.

An Aggressive Tax Plan Proposal in the U.S.

While there was cheer on the Euro front, President Trump sprung a modest surprise by coming forth with plans of a corporate-friendly tax culture in the U.S. In a nutshell, the tax proposals appear to benefit businesses, the middle class and high-earning individuals. Digging deeper into the numbers:

  • The corporate tax rate would be slashed to 15% from the current 35% (though in effect companies are already paying lesser than the 35%: S&P reports an average tax rate of 29.06% for S&P500 companies)
  • A low one-time tax levy on the ~$2.6 trillion in profits earned by U.S. companies overseas
  • A lower top rate and fewer tax brackets: condensing the existing seven income-tax rates to just three (10%, 25% and 35%), cutting the individual top rate to 35% from 39.6%
  • Doing away with a 3.8% net investment income tax applicable to individuals earning more than $200,000 a year
  • Repealing the alternative minimum tax, and
  • Eliminating the estate tax, which currently applies only to estates worth more than $5.49 million for individuals and $10.98 million for couples.

Markets Remain Skeptical of the Plan’s Passing and Viability

  • The plan is likely to face opposition in Congress and needs to pass in both chambers – the Senate and the House. Further, the Senate Budget Reconciliation rule prevents any tax plan from adding to the federal deficit outside a 10-year window — if it is enacted with a simple majority rather than 60 votes.
  • Consequently, U.S. equity markets have not responded favourably. The bond market exhibited rising yields with the 10-Year Treasury rallying 10bps vs. a week ago as traders focused on the potential ballooning of the fiscal deficit. Various estimates from the Committee for a Responsible Federal Budget (CRFB) and from administration officials peg the cost of the program at $3 to $7 trillion in terms of potential lost revenues.
  • Steven Mnuchin, U.S. Treasury Secretary and others expect the plan to stimulate economic growth to cover these costs. The CRFB has said that GDP growth would have to rise to 4% to achieve neutrality – which appears a tall order.

The U.S. Fiscal Deficit Currently at ~$600B Would Balloon Dramatically Under the Proposed Tax Plan

Riding the Wall of Worry


Early Earnings Score Card for Q4FY17

The earnings finale for the year has kicked off with most flagship companies of the NIFTY 50 reporting strong top-line growth barring IT majors, which is understandable given the broad slow down seen in the sector in terms of painful revenue transition from deal pipelines.

  • The early indications remain that performance is likely to be dispersed, both across sectors and stocks.
  • Secondly, existing leaders in the Financial space appear to be continuing their market leadership, with Axis Bank being the exception.
  • Operating leverage has not yet kicked in across sectors, and operating margin and net income margin performance has been mixed. We continue to hold the view that operating performance will improve over coming quarters as companies benefit from rate transmission and a recovering economy.

Performance Amongst the Nifty 50 Has Been On the Whole Quite Solid, Giving the Markets Cheer

Riding the Wall of Worry

Sector Performance

So far, 13 companies from the NIFTY 50 and 47 from the CNX 500 have reported earnings. From this limited set, a top-down sectoral perspective suggests the broader market is doing better than the NIFTY 50, driven by strong top-line growth in Materials, Financials and Consumer Discretionary.

Looking at profits, things look decidedly impressive, so far, for the CNX 500. Sales growth is double digits or higher for all sectors except IT and Utilities. Net profit growth is also similarly strong for Materials, Financials, Discretionary and Industrials.

Performance Has Been Stronger and More Consistent On the Broader CNX 500

Riding the Wall of Worry

Earnings Scorecard

While earnings have in general been positive so far, the same has been reflected in earnings surprises as well. The most striking being the resilient bottom-line delivery of Materials in both the mid and large cap space which has been driven by strong top-line beats. Financials have been another positive surprise as banks have delivered strong loan book growth (for instance, sustained stellar advances growth at Yes Bank) alongside hopes of potential resolution of the NPAs.

Net-net, the earnings results have so far been robust. We note that the first set of numbers are usually strong, and further clarity will emerge over the month. The bright spot so far has certainly remained the Materials space.

Overall bottom-lines (net income margins) have appeared a tad depressed. Despite this, most the CNX 500 companies (58%) have not disappointed. On the large cap front, India Inc. has fared even better with only 15% falling short of expectations.

58% of CNX 500 Companies Have Met or Exceeded Expectations

Riding the Wall of Worry

85% of Nifty 50 Companies Have Met or Exceeded Expectations

Riding the Wall of Worry

Political Stability And a Pickup in Fiscal Spend

With earnings season off to a cheerful start, the results of the recent elections provide further comfort to the markets. With the Government now entering its 4th year in office, and eyeing re-election in 2019, we expect a pickup in spending in H1FY18. Thus, we would expect infra spending to assist Industrials and Capital Goods related sectors in the Infra value chain. Materials have already started showing signs of good earnings performance.

Markets were further comforted by the BJP’s win in the Delhi Municipal Elections. The Delhi civic elections only add to the ruling party’s image of invincibility and leaves a divided opposition further demoralised in the run up to the national elections in 2019. The BJP has held its stronghold in the MCD elections continuing its winning streak last seen here 5 years ago.

Fixed Income

The major needle-mover for the 10-Yr G-Sec here was the heightened anticipation of inflation rearing its head as 2 members of the RBI’s MPC had hawkish views on the growth of the economy. In fact, Michael Patra, explicitly favoured a pre-emptive 25bps increase in the policy rate at the MPC’s last April meet to help attain the 4% target. This, in his opinion, would have obviated the need for a back-loaded policy action later when inflation would be unacceptably high and entrenched. As a result, G-Sec yields have moved slightly higher and now trade at 6.96% levels.


Trailing P/E valuations on the CNX 500 have reached 27.6x, still below Sep-16 levels of 28.6x. Arguably, this expensive 15% valuation premium to historical 3-year levels seems justified as earnings growth momentum has been gathering steam recently.

While over the last 3 years, CNX 500 earnings have grown ~3% p.a., the majority of this growth is back end loaded. In other words, growth has been coming through in the last 3 months (7% unannualised) and last 1 year (5.3%). The growth momentum in fundamentals is likely to continue.

Going forward, we expect markets to continue to gradually climb the wall of worry, which is a healthy sign. Index level appreciation going forward is likely to be driven by continued growth in earnings, with valuations playing second fiddle.

Technical Strategy

The Nifty witnessed a 2% gain for the week to close at 9304. After the last six weeks of range bound action, the index is seeing a breakout from sideways consolidation with good price action to close above 9300 levels.

On the upside, the next technical level for the index is at 9570. In Nifty Call options, the highest open interest was at 9500 strike thus suggesting market is likely to head towards 9500-9570 levels. Though momentum indicators have flattened out or turned down from higher levels on the weekly chart, as long as price continues to make new highs and higher lows, the uptrend still remains intact. Hence only a breach of the previous swing low levels 9075-9024 would be a sign of caution in the market.

In Nifty Put options, the 9000 Strike price has the highest open interest followed by 9100 strike suggesting that 9100-9000 is the base for the market. FPIs have been negative for April with an outflow of Rs. 2245 crores (provisional) and domestic inflow of Rs. 11845 crores (provisional) for the month, which has taken the market higher.

Negative correlation between Nifty and India VIX continues to hold as market is hitting new highs while volatility is hitting multi years low. But any sharp spike in VIX or divergence in correlation would worry the market. Until then the market uptrend is likely to continue.

Riding the Wall of Worry