New Year strategy notes from brokerage firms show greater preference for value stocks, especially shares of companies with low valuations and limited downside risks to earnings.
One example is a note by IIFL Institutional Equities that says, “We believe 2017 could see value stocks outperforming growth stocks as investors start to question the premium being paid for growth, which itself has, at least temporarily, become uncertain.”
Some, including IIFL, even added power and gas utilities to their overweight themes for 2017, citing their stable earnings potential. The consumer discretionary theme is mainly off the radar.
“We focus on sectors like public sector utilities especially in power (transmission) and gas sectors (transmission and distribution), where cost plus business models and assured post tax returns impart significant earnings stability. We also like OMCs, which are expected to show strong earnings going forward,” Antique Stock Broking Ltd said in a note. OMCs is short for oil marketing companies.
That is a remarkable shift for the market which is known for growth stocks. What explains the change in preference when the demonetisation-induced economic disruption is largely seen to be transient? It’s probably lack of clarity. Analysts are unsure how long the business disruption from the current cash crunch will last.
So, cuts in earnings estimates were modest, though many see downside risks. “Growth forecasts for FY17E/CY16E are clearly at risk due to the short-term cash shortage disruption. Risks to absolute earnings numbers for FY18E/CY17E are also on the downside, though growth numbers might not look too bad on the lowered base,” Jefferies said in a note.
As Kotak Institutional Equities points out in its 16 December strategy note, most growth stocks rerated significantly in recent years, making them unpalatable from a valuation perspective. But things from the earnings perspective are not rosy either. Demonetisation has punctured the consumption-led demand recovery thesis.
The risk emanates from what Jefferies terms as behavioural changes. The government crackdown on the informal economy can hit spending patterns of the people concerned as their incomes and wealth (in terms of real estate prices) will be hit. This can have adverse implications for the formal economy, says Jefferies. “To assume that the lasting impact of the anti-hidden wealth measures hurt only real estate demand and not demand for other consumer durables would be taking an overoptimistic view of the situation. We expect a general fall in risk appetite and willingness to spend,” adds the brokerage firm.
IIFL echoes the views. According to the broking firm, there is a loss of confidence among the (informal) businesses on future policy action and they may take time to regroup, delaying the return of normalcy and undermining economic activity. “Thus, it seems to us that on balance economic activity will not revert to the earlier trend immediately after liquidity is restored,” adds IIFL. “Recovery from demonetisation-led slowdown is likely to be gradual, with growth estimates taking a hit even in FY18 and not just in 3Q FY17.”
While the situation is still evolving, growth uncertainty is bringing value stocks back into reckoning.