Downgrade in future earnings growth could pose biggest risk to markets in FY24

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After facing many challenges, the fiscal year of FY23 has ended. The economy and market bore many from supply constraints including hyperinflation, the overvaluation saga of India’s largest conglomerate, and the collapse of international banks due to mounting interest rates.

These concerns still linger and could bear consequences on the performance of the stock market moving ahead.

The broader market is down by only -2.3% in FY23 while from the 52-week high it is down by -9.2%.
In context with the ongoing risks, the market will start FY24 with a subdued sentiment and a volatile global market as investors worry about contagion to other banks, financial lenders, and the real estate sector.

For example, the US housing and commercial sectors are in recession, a key segment of the economy. The segment has been subdued since COVID and is now lingering further due to high mortgage rates.

The high cost of maintenance and the cost of refinancing is affecting the commercial segment. This can impact the performance of banks and the economy.

The total housing inventory is low, but the inventory & price of commercial real estate are high. The unconditional availability of liquidity to banks can limit the overall impact.

Thus, the possibility of a new bank failing is low, but the slowing businesses of banks and the economy will cloud over the stock market in the short term.

Whether the banking issue can spill over to the non-banking sector depends on the strength of the economy and business models.

The IMF foresees a slow economy, but in January it marginally upgraded the forecast for 2023 by 0.2% to 2.9% from 2.7% estimated in October 2022. This is to build in the reopening of China’s economy.

While in March, the Fed expects a marginal further slowdown in the US economy to 0.4% GDP growth, compared to the 0.5% forecasted in Dec. These forecasts are at low levels compared to the long-term range of 3.5% for the world and 2% for the US.

Clearly, it shows that the economic view is factoring in the worst. But it is not mirrored in the earnings forecast. For instance, in India, the GDP growth forecast is 6% for FY24, while the earnings growth of the Nifty50 index is at 20%.

This looks on the higher side, even if we consider that the nominal growth of the economy will be around 10 to 12%. High inflation, high-interest rate, and a slowing global economy will affect the quality of profit & valuation.

Hence, the biggest risk seems to be a downgrade in future earnings growth. The performance of Q4FY23 and Q1FY24 results will be the key root to accessing reality.

The flip side is that each of these issues, from recession to bank collapse has been pondered upon and absorbed by the market in the last 1.5 years. The market has been trading with a negative bias for a long period of time (528 day, 18 months).

The Nifty50 return from 21st October 2021 to 31st March 2022 is -5%. In this period, Mid and Smallcaps have undergone a drastic loss in price and this long consolidation will limit further downside.

Now, the market is in a remedy mode in the aftermath of the issues. A relief rally is possible in the short term given the deep correction YTD and some stability visible in global banking stocks recently.

Looking at the broad horizon of the coming fiscal year, the end appears to be at low risk. The possibilities of the stock market ending stronger are bright as the market has started factoring the loopholes and moderation in valuations.

The monetary policy will reverse from hawkish to neutral in the coming quarters. An investor who will be able to harness the chaos will end up as the winner of FY24.

First published in The Economic Times

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