A lot depends on banking sector to take market higher

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The financial sector has been among the worst-performing segment in equity asset class, while the main and broad markets have been rallying through the 52-week low seen in the month of March. Currently, the main indices have inched higher, near to the all-time high and that too very quickly, while the banking sector is heavily under performing hovering near the 52-week low level. YTD Nifty 50 is down by only -8% while Nifty Bank is down by -32% from their all-time highs respectively.

The key reason for the financial sector to be so weak is because it was already under tremendous pressure from weak asset quality and low credit growth due to legacy issues, shadow banking, and a slowdown in the economy during the last three fiscal years. The government and RBI were working on these issues for some time and have been working towards implementing adequate changes in regulation, management, and bankruptcy code. By the start of 2020, the outlook for the banking sector was improving with a reduction in NPA forecast, an increase in the availability of funds, and an upgrade in economic growth. By then the Gross NPA level of scheduled commercial banks was forecasted to fall to 10% by September 2020. New credit growth was expected in the domestic economy due to new private investment based on the corporate tax cut, fiscal and monetary reforms in tandem with the government’s vision to reach a $5 trillion economy by 2024. A major beneficiary of this vision was expected to be the banking sector because the economy will not be able to expand in such an exponential manner without an efficient banking system with healthy credit growth and fall in systematic risk.

Now, this view has reversed, because the sector is not able to move out of the legacy issue while Covid lockdown has increased NPA level and there is a fall in credit and economic growth. New NPAs are expected to pop-up post moratorium period which is capped till August 2020 while GDP forecast is expected to contract by -3.5% to -9.5% (range of forecast by international and domestic institutions). This means that the $5 trillion economy dream has been pushed back by about three more years. Credit growth has collapsed and the market is not expecting growth in earnings for the next 12 to 18 months. As per the latest RBI assessment, Gross NPA is likely to increase to 12.5% on an average basis while in the worst-case scenario, it would be 14.7%, which has not been factored in the market. Current relaxation and moratorium do not depict the correct NPA level in the system, while the economic recovery forecast has turned wide due to unknown economic outcomes.

The key question is whether these issues have been factored in the bank’s stock prices. Broadly, Nifty Bank which includes the best set of 12 banks of big to medium size, is valued at 1.55x 1-year forward P/B. This is after touching the 7-year low of 1.1x, so we can assume that it has factored a lot and is trying to reconcile due to uncertainties in near to medium-term regarding post moratorium and re-opening of the economy. We feel that accumulation is the best strategy for banks, especially by investing decent amounts, as per investors aversion, through SIPs for the next six months. For the equity market to perform well, a lot will depend on the performance of the banking sector which is the main nervous system of the economy and market, accounting for more than 1/3rd of India’s total Mcap.

7 COMMENTS

  1. Yes Banking sector will play important role in upward movement of market. Despite headwinds mentioned in your article, several brokerage houses are recommending banking stocks particularly private banks at the current price. What is your view Sir?Sir, are bank stocks worth investing at current market price. If yes, can you suggest the names?

    • Indian banking sector is a strong value buy, on a long-term basis. Today, the sector has headwinds like lack of credit growth, weak asset quality and high risk of increase in NPAs in the future. This may impact the sector for the next 2-4 quarters. On a positive side, the valuations has dipped near to decades low level. Few stocks which we believe are best placed in the industry to overcome this issue ,and available at fair prices are HDFC Bank, Kotak and IDFC First Bank.

    • The company has the largest order backlog in the country, which brings stability. However, execution & outlook is weak today, given the economic situation. We can expect recovery in construction sector in the coming quarters. Scenario has improved a bit with early signs of a pick-up in order & execution. Additionally, the acquisition of Mindtree stake should aid growth in its IT&TS vertical and boost the overall margins, going forward. In the short to medium-term, infra companies can underperform the market.

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