Markets near record highs, but will the rally sustain?
Samvat 2073 ends with gains; earnings to be key ahead
MUMBAI: A lack of earnings visibility and high valuations cloud the outlook for Indian stocks in the next Samvat, the Hindu calendar year that starts on Diwali, analysts said. The markets closed Samvat 2073 near record highs despite the twin shocks of demonetisation, or the invalidation of high-value banknotes on November 8, and the implementation of the goods and services tax (GST) on July 1.
On Wednesday, the Sensex lost 0.08%, or 24.81 points, to close at 32,584.35 points, just shy of its all-time closing high of 32,633.64. Similarly, Nifty lost 0.23%, or 23.60 points, to close at 10,210.85 points, a tad below its record closing high of 10,234.45.
“The rally henceforth will be a function of earnings recovery,” said Gautam Duggad, head of research (institutional equities) at Motilal Oswal Securities Ltd. “The market has limited room for price-earnings (PE) re-rating.”
The Sensex and Nifty are currently trading at 18.3 and 17.9 times their one-year ahead earnings respectively, much higher than their long-term averages.
Although the Sensex and Nifty have rallied 16.66% and 18.38% respectively in the justended Samvat, muted corporate earnings have raised concerns on valuations which may have led to the flight of foreign money in the latter part of the year. Fund flows from foreign institutional investors (FIIs) amounted to $865.7 million in Samvat 2073, down 85% from the previous year. That the markets continued to rally despite that was thanks to robust investments by local mutual funds and insurance companies. Domestic institutional investments in local equities grew 339.01% from a year ago to ₹9,7597.15 crore.
While it is possible that investor sentiment may remain positive so long as the domestic flows remain robust, such a rally won’t be sustainable, analysts said.
“Eventually the markets will need to realign with fundamentals. Looking for returns in a flow-driven market can be risky in my view,” said Dhananjay Sinha, economist and strategist, Emkay Global Financial Services Ltd.
The wait for an earnings recovery may well take some time. Despite some recent economic indicators showing a turn for the better, such as industrial production growth rebounding to a nine-month high in August of 4.3% and merchandise exports growing 25.7% in September, the fastest pace in six months, the shadow of slow economic growth is weighing on investor sentiment and earnings.
Kotak Securities Ltd, for instance, expects Nifty company earnings for this financial year to rise by just 3%, even though it predicts profits to grow 23% in the next fiscal year. The securities house thinks that part of the potential earnings that were likely to come in fiscal 2018 are now spilling over to fiscal 2019.
A few analysts are also predicting that the GST roll-out will eventually boost growth by lowering logistics costs, arresting tax leakages and prompting companies to pass on more cost savings to consumers.
“The recent measures to simplify GST have been encouraging. Given a reform-led government at the centre, we have rea- son to expect resolution of sticky issues like bad loans in the banking system. The earnings yield of equities remains decisively favourable, and equities continue to hold an inherent edge over other investment avenues,” said Amar Ambani, partner and head of research at IIFL Wealth Management Ltd.
Duggad of Motilal expects earnings to recover as early as the third quarter of the current financial year, led by a low base, a pick-up in demand and rural consumption led by drivers like the formalisation of economy.
“Two quartersdown the line if the potential GST collection picks up steam, then government finances will be in a far better shape. That can propel heavy government expenditure on infrastructure and social activities,” said Rusmik Oza, headmidcap, Kotak Securities.