Mumbai: Indian equities continue to be on fire, with benchmark indices Sensex and Nifty touching new highs every other day. However, a bullish stock market need not necessarily indicate that all is well with the economy.

A recent analysis by brokerage firm Credit Suisse showed that the relationship between the economy and markets is tenuous at best.

“Not only are market returns more P/E (price-to-earnings) than earnings per share (EPS) driven, markets and economy also have different structures," Credit Suisse said in a presentation to the media on 13 September.

Markets and the economy have different structures, meaning there exists a large informal economy, large parts of the formal economy may not be listed, and a large part of the market is driven by global factors or growing penetration and share, it said.

India’s quarterly growth saw a sharp deterioration from 7% in the third quarter of fiscal year 2017 to a three-year low of 5.7% in the first quarter of fiscal year 2018, hurt by demonetisation and implementation of the Goods and Services Tax (GST). However, the market’s continued ascent does not reflect the pain caused by either of these events to the large informal sector, which is a key contributor to the GDP and generates a large number of jobs.

“Normally, GDP growth and EPS growth should be in tandem. However, that correlation is broken many a time in emerging markets, partly because GDPs in EMs (emerging markets) are dominated by small, medium and micro enterprises, and larger enterprises contribute far less than that in the developed world," said Nilesh Shah, managing director of Kotak Mahindra Asset Management Co.

“Recognition of non-performing assets (NPAs) has distorted EPS growth lately. It deteriorated of late as NPAs got recognized and accounted for in the books," added Shah.

Also, limited clarity on GST’s impact on corporate balance sheets could delay a meaningful earnings revival and pose a threat to EPS estimates of fiscal years 2018 and 2019. But the market seems to be unfazed by these concerns.

The analysis added that if one splits the BSE 500 firms based on market capitalisation and classifies stocks by their key drivers, then the results would show that 25% of the BSE 500 market cap is almost completely driven by global factors.

“If the global economy is booming, it would in turn have its own positive implications on the domestic economy too," said Gautam Chhaochharia, head of research at UBS Securities India Pvt. Ltd.

“GDP growth is a mix of different factors. It includes the non-listed space, and focuses on output that is produced. The contrast and composition is very different for the earnings and market capitalisation of the listed space. Around a quarter of listed space’s earnings are also linked to global audience and markets, so that is a part of the disconnect too," Chhaochharia said.

Around 22% of BSE 500 companies based on market cap is driven by local macro (stocks that are impacted by macro factors such as export oriented firms), 11% by market share (private sector banks and telecom), and 42% by penetration-driven stories (stocks driven by certain themes such as rural consumption), showed the Credit Suisse research.

Sharing a similar view, Sanjeev Prasad, managing director and co-head of Kotak Institutional Equities, said the recent worsening of India’s macroeconomic woes may be paradoxically better for the Indian market’s earnings given the high share of companies with US dollar-linked revenues and profits in the overall revenues and profits of the Indian market.

“We note that the recent depreciation in the INR against major currencies may provide support to our FY2018E and FY2019E earnings estimates given the high share of companies with US dollar-linked revenues and profits in the overall revenues and profits of the Indian market," Prasad said in a note on 5 October.

“This is especially true for the major indices with 45% and 50% of the net profits of the BSE-30 and Nifty-50 indices having direct and indirect linkages with the currency," added Prasad.

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