In April, the Indian broad market witnessed a solid rally of 4.5%. This is compared to -5.8% from Jan to March 2023. The rally is occurring despite mixed economic development.
In April, India witnessed a surprising pause in the RBI rate hike policy, which is positive and below expected FYQ4 results.
Both factors are likely to play a crucial role in the future structure of the stock market.
The change in monetary policy is predicted to cause a decline in market yield in the medium-term, while weak Q4 is likely to result in a downgrade in the forecast.
The 10-year government bond yield of India has reduced by 25 bps to 7.1%. This is expected to lead to an ease in stock market volatility by curtailing derate in valuation as the cost of funds moderates and the availability of funds increases in the future.
The one-year forward P/E valuation of India has reduced by 10% in the last year from 20x to 18x, which is just a notch above the seven-year average of 17x.
Along with that, the future trend of India’s valuation will depend on two key factors: the earnings outlook and global stock market sentiment.
Looking at earnings, the outlook on future growth moderated as below-expected Q4 results were announced in April. It was initiated by a subdued IT sector with a cautious outlook on FY24, slowness in global business expenditure & decisions.
It led to a downgrade in India and the IT sector’s EPS growth. IT sector earnings growth was downgraded by about -5%. It led to a sell-off in IT stocks and had a consequence on the broad market.
In total, 19 out of 50 Nifty companies have announced results. In that, the banks have performed marginally better than expected.
This improvement can be attributed to a reduction in Non-Performing Assets (NPAs) and a pickup in Q4 credit growth, which has instilled confidence in investors. Auto numbers are recorded above the market estimate owing to strong volume momentum in the passenger vehicle and two-wheeler categories.
But the total performance of the companies is weak. These 19 companies’ cumulative PAT growth was estimated at 11%, whereas actual growth is 3.6%.
Broadly, the outlook for near-term earnings has moderated due to a slowing economy and high operating costs. The total revenue growth of the 19 companies was 13%, in line with the estimate of 12%.
So, the key culprit is high inflation. Luckily, global inflation is coming down drastically. The market expects an improvement in profitability on a QoQ basis.
This should be a factor in the current market rallying, hoping for better earnings from next quarter.
Unfortunately, the global economy is in a recession. The latest data reveal that the US economy grew at a small rate of 1.1% in Q1 2023, much below the market expectation of 2%.
And consensus is that this trend will further slow down during 2023 due to high interest rates and a lack of business investment. The GDP QoQ consensus is 0.3%, -0.6%, and -0.3% for Q2, Q3 and Q4, respectively.
In this context, India is forecasted to grow EPS by 18% in FY24, which we believe is on the higher side.
Presumably, a further downgrade in earnings is the biggest risk for the market, a realisation may happen during the end of the ongoing Q4 result or in the Q1FY24 result.
In such a situation, we believe that the companies most impacted by a downgrade in earnings will be those having high exposure to the global economy, like exports.
Whereas the companies which are highly grounded to domestic business will be safe. Such companies will be able to improve profitability due to a drop in the cost of operations led by a fall in global inflation and stable business outlook.
Investing in domestic-focused businesses will be worthwhile in such a mixed situation.
First published in Economic Times
