Markets bet on surge in earnings growth

Analysts are factoring in a 45% rise in corporate profits in next two years

India has the most aggressive earnings growth forecast among the world's major stock markets, and that is probably why the Sensex and the Nifty are continuously scaling new heights.

The combined net profit of the BSE Sensex and NSE Nifty is expected to rise around by 45 per cent in the next two years in constant currency terms, beating most other markets by a wide margin.

Bulls have raised their earnings expectations despite India Inc’s poor earnings growth in the last few years. The combined earnings (in dollar terms) of Nifty companies were down 0.8 per cent cumulatively in the last three years, while the earnings of Sensex companies were 5.4 per cent lower during the period.

The UK’s FTSE 100 is expected to top the growth chart with its underlying earnings rising 74 per cent by the end of December 2018 from their current level. The FTSE 100 index is, however, not comparable with India's benchmark indices because of a large presence of metal and mining companies that are witnessing a rebound after years of poor performance. Metal and mining companies have a small weight in Indian indices.

The analysis is based on the forward earnings estimates of the world’s major equity indices in dollar terms as compiled by Bloomberg.

Experts see a bull bias in the forward earnings estimates, given the strong performance of Indian stock indices during the year. "There has to be a justification for the recent rally on Dalal Street and the rich valuation for most frontline stocks. Analysts are justifying the rally by building in expectations of strong double-digit earnings growth over the next two years," said G Chokkalingam, managing director, Equinomics Research & Advisory.

According to him, this is normal in a bull run, but investors should take it with a pinch of salt. Investors, however, seem to have taken the forward earnings estimates at face value, pushing the benchmark indices to new highs and making India one of the best-performing markets in dollar terms in 2017. (See chart)

The Sovereign Gold Bonds (SGBs) scheme in its new avatar as approved by the Union Cabinet on Wednesday is expected to be a success. The opportunity to invest without waiting for new tranche announcements was one aim of the change. The annual purchase limit was also raised considerably, for individuals till four kg a year, from 500g, and for trusts and notified entities to 20kg.

Investors may, it was decided, now buy bonds like systematic investment plans (SIPs) for mutual funds. They may go for recurring deposits of SGBs through post offices, choose to buy when there is liquidity, gift it on occasions and also buy when prices are lucrative. However, details on what the goveernment meant by saying these would be available ‘on tap’ are still unclear. Does it mean daily bond offering, with daily price fixing? Or some other mechanism? Says a veteran bullion analyst, “On-tap could simply mean more frequent issues of SGBs, with different features.”

The announcement after the Cabinet decision was: “Flexibility has been given to the ministry of finance to design and introduce variants of SGBs, with different interest rates and risk protection/payoffs that would offer alternatives to different categories of investors.” There was mention of changing the features to reduce the time lag between tranches, to deal with a dynamic and sometimes volatile market, macro economic and other conditions, such as the price of gold.

For dynamic feature issues, though, price benchmarking is crucial. Indian Bullion & Jewellers Association (Ibja) suggests the bonds be issued on their previous day's closing price or the past one-week average closing. An expert suggests the volume-weighted average for all gold contracts on the Multi Commodity Exchange be considered for pricing of regular bond offerings.

Ashish Chauhan, managing director of the BSE exchange, said: “It is a welcome move. There was a demand by investors to increase the investment limit. Similarly, an on-tap framework will make it easy for people to subscribe when they want. Market making will provide liquidity to investors. Overall, this will increase the attractiveness of investment in SGBs.”

On how bonds can be sold on-tap, he says, “It is possible like mutual fund selling, using exchange infrastructure. At the time the bonds are issued to an investor, these can be listed as additional bonds. Technology is available with exchanges to provide this platform.”

Adding: “SGBs have the potential to reduce India’s trade deficit by $15-20 billion (~96,000-1.2 lakh crore) per annum.” Market making and improving the liquidity of bonds listed will be key for success.

Sudheesh Nambiath, lead analyst for precious metals at GFMS Thomson Reuters, says: “With no GST (goods and services tax) on SGBs and no holding cost, it now becomes an attractive instrument for diversifying one’s portfolio. It would be easy to achieve 50 tonnes of investment demand per annum divertion to SGBs.” At today’s price, the value of 50 tonnes is ~14,250 crore or $2.2 bn.

According to the government, SGBs have attracted ~4,769 crore, against a target of ~15,000 crore in FY16 and ~10,000 crore in FY17. If the scheme takes off as expected, physical demand for gold and, hence, its import will come down. In recent years, the investment demand for physical gold has been 160-200 tonnes a year.

While there is no data available on how many investors had exhausted their earlier annual limit of 500g in SGBs, the revised scheme will have potential for wealthy investors, trusts and like entities to put more money in gold bonds. Shekhar Bhandari, senior vice-president at Kotak Mahindra Bank, says: “The revised SGB scheme is much more attractive and will attract wealthy investors who were not interested in the (earlier) size of 500g or ~15 lakh per annum. More investment from them can be expected now.”

A bullion analyst says: “For trusts, having a much higher investible corpus, the increase in limit to 20 kg or ~5-6 crore per annum is attractive. The government could have considered a much higher limit for them.” Nambiath says, “It is intriguing when you compare the limits set on physical holding and paper holding.”

Surendra Mehta, secretary of Ibja, said: “It will be interesting to know how the government prices the ontap sale of bonds. If bonds are likely to be sold like mutual funds, will the tax treatment be like on MFs?” The latter have one to three years for capital gains tax exemption; in SGBs, capital gains exemption is available if held till maturity. Mehta also wanted to know if the discount offered to SGBs of ~50 per gram and annual interest rate of 2.5 per cent would continue or be brought in line with MFs.

Ibja also suggests that gold exchange-traded funds be allowed to convert their holdings and invest it in SGBs.