Expectations on earnings drive market rally
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Mumbai: Benchmark equity indices hit new lifetime highs for the seventh day in a row on Wednesday as investors bet that corporate earnings will receive a boost from higher economic growth, making India one of the best-performing markets so far this year.
The 30-stock BSE Sensex ended 0.45% higher at 27,139.94 points and the National Stock Exchange’s Nifty closed up 0.39% at 8,114.60. Both are record closing highs.
Wednesday marked the ninth consecutive session the indices ended with a gain and the seventh that they rose to records. In these nine sessions, the Sensex, India’s most closely watched market barometer, has risen 3%, extending its gain since the start of the year to 28.2%, making it one of the world’s best performers.
While easy global liquidity and hopes of an economic revival under the new National Democratic Alliance (NDA) powered the markets in the initial phase of the rally, investors are now wagering that an economic rebound will translate into higher corporate earnings.
Asia’s third largest economy grew 5.7% in the three months to 30 June, the fastest pace in 10 quarters, driven by strong industrial output, data released on Friday showed.
To be sure, softening of global crude prices and a strong risk appetite globally continue to play a role as well in driving the markets higher. Foreign institutional investors have pumped more than $13 billion into Indian equities so far this year.
Analysts expect the earnings per share (EPS) of companies linked to the Sensex to grow in the range of 15-21% in fiscal 2016.
“We are at the start of a long earnings upgrade cycle, but it takes time for economic growth to translate to earnings growth. It will not happen immediately. We will see some improvement trickling in from FY16 (fiscal year 2016) onwards,” said Raamdeo Agrawal, joint managing director at Motilal Oswal Financial Services Ltd.
In a note last month, Motilal Oswal Financial Services raised its Sensex EPS forecast for fiscal year 2016 to Rs.1,854, an increase of 21%; it had earlier estimated an increase of 20%. It expects fiscal 2015 EPS to increase by 14% to Rs.1,532. The Sensex EPS rose 13.4% in fiscal 2014 and 5.3% in fiscal 2013.
Corporate earnings growth has slowed over the last couple of years, led by pressure on the earnings of sectors linked closely to the domestic economy, which slowed to a growth pace of less than 5% in each of the last two years.
Some analysts expect the earnings upside to stretch out over at least the next four years.
“We continue to reinforce our message that earnings are set to double over the next four years to FY18 and market returns could mirror earnings growth,” Bank of America-Merrill Lynch analysts Jyotivardhan Jaipuria and Anand Kumar wrote in a 1 September note.
Edelweiss Securities Ltd expects Sensex earnings to grow 15-16% through fiscal year 2016. It values the Sensex at 16 times FY16 earnings—a 6% premium to the historical average, and sees a re-rating possibility in FY16 with more visibility on supply-side reforms.
“The earnings cycle will continue with a positive momentum from here onwards on the back of improving economic fundamentals. Falling crude prices, softening inflation, rising consumer spending and improving corporate sentiment, which will eventually revive investments, will support growth and corporate earnings,” said Nilesh Shah, managing director (MD) and chief executive officer (CEO) of Axis Capital Ltd, which expects Sensex company earnings to grow 17% in the current fiscal and 18% in the following year.
Others are even more optimistic and base their optimism on an anticipated expansion in production capacity at companies such as energy giant Reliance Industries Ltd.Deven Choksey MD and CEO at KR Choksey Shares and Securities Pvt. Ltd. Choksey expects Sensex earnings to record a compounded annual growth rate of more than 20% in the next three fiscal years.
“It is obviously clear that mining, metals and infrastructure, which have not contributed for some time, will now start delivering growth, as new projects pick up and the stalled ones restart,” said Choksey.
While most analysts say the markets, at current levels, have factored in the expected upside in earnings, some such as CLSA say the foreseen improvement in corporate financials is still to be accounted for.
“Having endured three years of earnings downgrades, investors are reluctant to factor in large upgrade possibility,” CLSA said in a note on 2 September.
“History suggests that during an upturn, consensus usually underestimates the extent of earnings growth. We expect this time to be the same,” CLSA analysts added.
According to Bloomberg’s best estimates, the Sensex is trading at 17.3 times one-year forward earnings compared with 23.73 times in January 2008 at the peak of the last bull run.
In the last upcycle, the Sensex jumped more than seven times between April 2003 and January 2008.
It has gained 37.5% since 13 September 2013—the day the Bharatiya Janata Party named Narendra Modi as its prime ministerial candidate for the general election that brought the party back to power after a 10-year hiatus and installed Modi in the nation’s highest executive office.
“At this rate, the market is not cheap, but it is not expensive either. It is still early days for Modi. We will have to wait and see how deliveries pan out,” said Agrawal of Motilal Oswal.
Modi, perceived to be pro-business and pro-markets, has promised to revive economic growth and boost job creation.