Looking forward - 2018: Motilal Oswal sees high tide for fixed income

Once again, it’s that time of the year when experts across the world are expected to gaze into the crystal ball and predict what the future holds, notwithstanding the fact that most of previous year’s forecasts are way off the mark. Same time, last year, demons of uncertainty on account of demonetization and the outcome of the US presidential elections had clouded the investment outlook. Investors have been caught on the wrong foot as the year has been rewarding for equity investors, not as envisaged in the beginning of the year. Markets appear to have shrugged off concerns arising from the implications of these events and have climbed the wall of worry. But even as markets appear to be scaling new heights, lack of earnings appear to be the missing ingredient in the making of a perfect recipe. 

The worst appears to be behind us. With the effect of demonetization and GST waning off, economic activity is likely to be on the rise, which can be attributed to a confluence of factors such as normal monsoons, farm loan waivers and the recent MSP (Minimum Support Price) hikes. In addition, the boost in salary of government employees is likely to augur well for consumption. 

One of the biggest problems plaguing India’s economy is the twin balance sheet problem i.e. highly geared balance sheets of corporations in the industrial sector and huge NPAs (Non Performing Assets) in the books of state-owned banks. The government has dealt with this problem decisively by announcing a massive recapitalisation plan for the paralysed Indian public sector banks. This is likely to induce the much needed confidence in the economy and kick-start the investment process. The said developments have benefitted India with an upgrade in its sovereign rating, which is an endorsement of potential long-term benefits these reforms are likely to have. 

With regards to equity investments, we believe investor expectations have been on the rise on the back of strong equity performance that has been experienced. At this juncture, one needs to tone down one’s expectations and not make recent experience a basis for future returns. Risks are always present and it would be unwise to ignore them. In the past, abundant global liquidity has powered equities around the world and a significant reversal in liquidity will challenge the prevailing valuations. India’s growth has been muted over the past couple of years and expectation is that this would reverse in the coming year. Trailing valuations are not an exact science that can forewarn precisely at peaks and troughs, but they do forewarn us to be prepared. Given this backdrop,  we continue to recommend that investors  invest in equities systematically and use any corrections to increase allocations.

Contrary to popular wisdom, this year, fixed income was more volatile than equities in India. We started with interest rates being benign on the back of demonetization with 10-year yields close to 6.4 per cent and expectations of a rate cut due to expectations of weak growth. However, RBI quashed expectations of rate cut by moving its stance to neutral while signaling a higher than expected inflation forecast. Further with Federal Reserve hiking rates and commodity prices on the rise, the central bank seems to have missed an opportunity to cut rates and will find it increasingly difficult to do so with global rates on the rise. It was not a rewarding year for fixed income investors and I continue to recommend investors to stick to low maturity funds with strong accrual yields. FMP (Fixed Maturity Plan) opportunities should be explored in 2018 with yields on the rise.

What lies in store? We continue to be positive on equities, however expect increased volatility and lower returns in the future. It will still be the preferred asset class to be in with double digit expectations. Fixed income should do better this year as yields stabilize; returns will be higher than last year. As the saying goes: “It is difficult to predict the tide or the weather, however, a sturdy ship is the best hedge against turbulent weather”. Stick to your asset allocation, do not swing with the market tides and you will be reach your destination. 

Motilal Oswal is the Chairman and MD, MOFSL (Motilal Oswal Financial Services Ltd).