When the yield on India's 10-year sovereign bonds rises to 7.3-7.5%, the risk-reward ratio for Indian equities would begin to deteriorate, said Jignesh Desai, chief executive officer, institutional equities, Centrum Broking. A risk premium on crude fades once tensions cool, and a blocked Strait of Hormuz does not remove the risk premium, he said, explaining why crude oil prices remain at $95 per barrel. The central bank's policy signals, the state of rabi sowing, and September quarter earnings could be key triggers in the coming months, Desai said in an interview. Edited excerpts:
The Nifty has not made a new high for a considerable period. What does this tell us about the current market environment and investor sentiment?
The Nifty has not made a new high since early January and is roughly 10% below that level. On the surface, that looks like weak sentiment. But the picture beneath is different. The June quarter was the strongest earnings quarter in some time, with index profit growth of about 18%. Estimate upgrades also outnumbered downgrades, while the forward multiple compressed to around 17 times earnings. In effect, the market has spent eight months consolidating while earnings have continued to grow. That has brought valuations down without requiring a large fall in the index. So, the sentiment is not broken. What remains missing is sustained foreign buying at scale. That has more to do with the global cost of capital and currency returns than with investors losing confidence in India’s earnings outlook.
Following the Fed’s hawkish stance, do you expect global capital to move towards US bonds? Could this put further pressure on foreign flows into Indian equities?
Yes, higher US bond yields can put further pressure on flows into Indian equities. India cannot address it through domestic policy alone. That said, recent flow data have been better than the headlines suggest. Foreign investors net bought Indian equities for three consecutive months, with August inflows close to ₹300 billion. The buying has also broadened despite the Fed’s hawkish turn and the rise in crude. During the previous two years, expensive valuations and earnings downgrades weakened the equity case. Rupee depreciation then turned a flat local market return into a poor dollar return. Once the balance of payments stabilized and reserves were rebuilt, some of that risk was priced out and foreign buyers returned. From here, I would watch the yield spread rather than any single yield in isolation. We would see the domestic 10-year moving into the 7.3-7.5% range as the point at which the risk-reward for equities begins to deteriorate.
Brent crude is trading around $95 per barrel. Do you think the current price is largely reflecting a geopolitical risk premium, or are there genuine supply concerns?
The current rise in crude prices is largely driven by genuine supply concerns rather than just a geopolitical risk premium. Disruptions to shipping through the Strait of Hormuz are affecting the physical movement of crude, preventing barrels from reaching buyers on time. A risk premium fades once tension cools. A blocked route does not, and that is why this price has held. The test is what happens on good news. A pure risk premium deflates the moment talks are announced, and this one has not. Crude is also not moving alone. Coking coal is near its 52-week high and aluminium and copper are near theirs, which points to a supply problem across commodities rather than speculation in oil. For prices to ease, we need one of three things: the route reopening, demand falling because these levels are too high to absorb, or producers outside the region raising output. The first would work fastest, but is the hardest to predict, and we would not position for it. For India, the asymmetry is unkind, because relief arrives at once, but the cost of a long disruption builds through the current account.
What are the key triggers that could drive markets over the next few months?
The first is the RBI’s October and December policy meetings. Growth has been much stronger than the RBI expected, while inflation is moving higher. A hawkish signal would probably hurt the smaller end of the market most because valuations there remain demanding. The second is Rabi sowing from October onwards. That is when we will find out whether the monsoon deficit is beginning to affect agricultural output or not. The third is the durability of foreign buying. Three consecutive months of inflows is encouraging, but it has not yet been tested against the combination of higher US yields and crude near $96 per barrel. Finally, the September-quarter results will matter. One strong quarter was enough to turn the direction of earnings revisions. A second consecutive quarter of good results could change the multiple that investors are willing to pay.
What are the key sectors or themes you are watching in the market at present?
The main theme I am watching is the investment cycle, particularly the companies supplying the equipment and infrastructure behind it. Fixed investment grew close to 12% last quarter; so the question is where that spending translates into stronger margins. Renewable generation is running more than 20% above last year and now accounts for close to a fifth of electricity supply. With data centre demand adding to the load, much of the spending should flow towards transmission and electrical equipment rather than generation alone.
Then metals. Domestic steel prices are at four-year highs, earnings have improved for several quarters, and metals have attracted consistent foreign buying this year. In electronics, the opportunity is moving from assembly to components. Almost every phone sold in India is now assembled locally; so, increasing domestic value addition is the next step. Banks are interesting for a different reason. Credit is growing at around 19%, compared with deposit growth of about 15%. That would normally push banks to raise deposit rates, but the liquidity created through the RBI’s swap window has eased the immediate pressure.