Expect Modest Returns from Equity in 2018

Equity

The year 2017 was a fabulous one for equity investors globally. India has been one of the best performing markets. As on December 18, 2017 Sensex is up by 28.66 per cent for the year while Nifty is by 30.74 per cent. Nifty Midcap and Nifty Smallcap are up by 50.26 and 51.6 per cent respectively. These are handsome returns indeed! What is in store for investors in 2018?

There is, indeed, a bull case scenario, in spite of the high valuations. The ongoing global bull run is being primarily driven by the synchronized global economic recovery. All developed economies are doing well and there are no threats to global financial stability. The much-feared threats to the global economy in the early 2017 like a Chinese implosion triggered by their debt problem, break up of the Euro Zone following Brexit and increasing protectionism triggered by Trumponomics have receded into the background. Global economic recovery, coupled with low interest rates, has delivered decent earnings growth. The present Goldilocks economic scenario is likely to continue in 2018 and beyond. This can keep the markets buoyant.

Even though the Fed is tightening, liquidity is likely to be abundant since most central banks are pursuing an accommodative monetary policy. Developed market central banks are concerned about deflation rather than inflation. Therefore, most developed market central banks are likely to be behind the curve in 2018 ensuring adequate liquidity. This will be another factor favouring the bulls.

The argument against this bull case scenario is that bull markets will experience some sharp corrections at some point. Since markets are highly valued, they are vulnerable to a bear onslaught. This bear strike is likely to be triggered by some unknown and presently unanticipated event. The known risk in the market is the Fed tightening. If the Fed raises the rate thrice by 25 bps each and takes it to 2 to 2.5 per cent range in 2018, that would be on expected lines. But, if the tightening turns aggressive, it might trigger capital outflows from emerging markets, impacting stock and currency markets.

India was an exceptional case in 2017 where the bull run was not supported by growth and earnings recovery. Rather, the Indian bull run was a ‘hope trade’ in anticipation of growth and earnings recovery and this hope trade was powered by strong domestic liquidity. This hope is likely to materialise in 2018. If the recovery in growth, which has begun in Q2 of FY 2018, sustains and earnings growth revives, we are likely to witness a spurt in profitability. This will make valuations look reasonable.

The course of long-term bull markets has never been smooth. 2017 was a year of surprisingly shallow corrections. 2018 is likely to be different. It would be realistic to expect modest returns in 2018. Investors should look beyond 2018 and continue to invest. High priced small caps driven by momentum are becoming excessively risky. Companies run by managements of suspect and unproven quality should be avoided. Switching from high priced small caps to quality large caps would be ideal. Systematic investment in quality stocks and mutual funds should be the strategy for investment in 2018, too.