‘Index earnings yield is unattractive compared to bond yields’

What are some of the key takeaways from the June quarter results?

The net profit of Nifty companies was up 30% year-on-year (y-o-y) and operating profits were up 14% y-o-y. However, this growth is overstated as this was due to high non-operating incomes, and due to one-off profits at the oil marketing companies. We saw continued demand weakness in autos, fast-moving consumer goods (FMCG), chemicals and information technology (IT) services. However, we saw good results from capital goods and cement companies. In general, profit margins improved y-o-y as well as sequentially due to stable-to-higher product prices and stable-to-lower raw material prices.

Has the result season been able to provide impetus to forward earnings prospects and market outlook?

While there were sector- or stock-specific earnings upgrades and downgrades, in general, there has not been any meaningful change in our earnings growth outlook for FY24-25 which remains at 15% CAGR. Given that valuations are also not cheap, there has been no change to our expectation that the market will continue to consolidate around the current levels for the next few months and there is no major catalyst for a sharp rally or for a sustained correction.

What could prove to be key risks on the downside and triggers on the upside for the markets?

India’s valuations are not cheap—the Nifty trades at 21x FY24 P/E (price-to-earnings) and 18x FY25 P/E for 15% earnings CAGR (compound annual growth rate) in the next two years. The index earnings yield is also relatively unattractive as against bond yields. The key upside can come from a stronger-than-exp-ected demand in the festival season or due to pre-elect-ion spending, a quicker-than-expected decl-ine in US/EU inflation, or a sharp decline in global oil prices.

There are two main downside risks. First one is that global interest rates remain higher for longer than what the market expects, and the second is an increase in perceived political risk in India following the upcoming state elections.

The hawkish tone of the central banks suggests the interest rate cut decisions are getting further delayed. What can be the repercussions for markets?

Global bond markets are pricing in a rate cut by the US Fed in early 2024. However, so far, US inflation is not coming down as much as the Fed would like. Hence, Fed rate decisions may get delayed. If global interest rates stay higher for longer, that may adversely impact global growth and demand for risk assets - such as emerging market equities including India. In India, we expect the Reserve Bank of India (RBI) to hold rates steady for the next few quarters, and do not expect any major change.

How is India placed among other emerging markets and especially China?

From a macro and medium-term perspective, India appears very attractive given over 6% gross domestic product (GDP) growth prospects, a reasonably steady currency outlook, and stable interest rates. Nifty index earnings are also expected to grow at a 15% CAGR with many non-index companies growing much faster. This is unlike other EMs (emerging markets) like China where there are concerns over growth and policy uncertainty are concerning investors. Some other EMs like Brazil, Mexico or Indonesia are very export/commodity driven and hence very vulnerable to any global slowdown, whereas India is relatively less exposed. However, India’s valuations are not cheap. The Nifty trades at a 60% premium to the MSCI EM Index on a one year forward PE basis. Hence, most global investors are being cautious at the current levels but are eager to invest if the market corrects.

Is India still attractive for foreign portfolio investors (FPIs) considering volatility in such flows and will inflows sustain?

Yes, India is now a large part of the emerging markets index (14%+) and given China’s underperformance, there is greater interest in India. Also, it appears more likely as of now that the US economy may not slip into a deep recession, so that should keep risk appetite for EM equities healthy. Furthermore, we should expect some passive inflows later this month due to index rebalancing, and greater participation from FPIs in upcoming IPOs (initial public offerings) and in many equity block sales by PE (private equity) funds or promoters.

Should investors preserve cash or should they continue investing in the markets?

Over the next few months, we expect the market to be range-bound but we remain positive from a two-three year view and hence recommend equity investors to stay invested and buy on any dips over the next few months. However, investing in equities requires a relatively greater risk appetite and a long investment time horizon for returns to be attractive. Hence, each investor should consider their own risk profile and consult a qualified financial advisor on overall allocation for equities.