New Delhi: Indian stocks remain expensive as the corporate earnings potential and various macroeconomic factors do not justify the current level of the market, despite its recent downslide, according to Goldman Sachs.
“With valuations still elevated, notwithstanding recent market weakness and domestic investor sentiment bruised by poor performance of the high-profile Reliance Power IPO, we reiterate our underweight stance and expect the market to retrace further, or at best mark out a volatile trading range,” the global investment banking major said in its latest portfolio strategy report for Indian market.
Goldman Sachs analysts said that retail investors have been a key driver of the market’s strong rise between August 2007 and January this year, but their “speculative enthusiasm” has been dampened.
Besides, foreign investors are not as influential on price formation as they have been or are perceived to be, they said, adding that further net selling was expected from overseas investors “as more receive FII status and are able to trade around positions more freely”.
While pointing out that it continues to believe in the longer-term investment prospects of Indian market, Goldman Sachs said the earnings growth might not be sufficiently strong to allow the equity market to advance or hold its current level.
“Macro and earnings growth prospects remain good in absolute terms, but the mix of key macro variables is less favourable than it was in the latter part of 2007 when the market was in a bull trend. Moreover, the potential for earnings to positively surprise consensus expectations is low, in our view,” it said.
”The more subtle point is that the mix of macro variables is less favourable now than two quarters ago and earnings growth is less likely to surprise consensus expectations on the positive side,“ Goldman Sachs analysts said in the report.
Thus, in the context of high absolute and relative valuations, this macro and earnings outlook may not be sufficiently strong to allow the equity market to advance meaningfully or even hold its current level, they added.
Persistent earnings growth that Indian companies have delivered was one of the key drivers of the powerful bull run since 2003, not just in absolute but also in relative terms.
However, 2007 looks to be the first year since 2003 when earnings fell short of year-starting expectations, the report said. Furthermore, a shortfall in earnings growth, relative to expectations, could threaten the market’s ability to sustain its premium valuation, it added.
Goldman Sachs expects India to deliver close to eight per cent Gross Domestic Product (GDP) growth this year, but believes that the combination of key macro variables is less favourable now than it was two quarters ago at the start of the markets recent strong rally.
Specifically, industrial production is moderating, inflation is picking up, interest rates are unlikely to fall and the currency is likely to remain range-bound, at least over the next quarter or so.
Meanwhile, the prospect for earnings to surprise positively in 2008 and 2009 may not be possible, as the level of growth expectations in the two years are high in absolute terms and relative to history -- the current figures are 19 per cent and 22 per cent, the latter being the highest since the bull run began.
Estimate revisions for both 2008 and 2009 earnings have recently flattened and are starting to turn down.