Liquidity is driving investor sentiment, rather than fundamentals, say market analysts
investors are unfazed and are already pricing in a huge recovery in earnings for FY22
Indian markets have been riding on hopes of a better future for a while now, ignoring the reality of pain in the present. Excluding stocks of financials, the Nifty 50 index is back at its pre-covid highs of February, giving the impression that the pandemic will have almost no major impact on corporate earnings.
But now that Indian companies have begun reporting results for the June quarter, a moot question is if investors will finally wake up and smell the coffee.
As far as the fiscal-first quarter earnings go, analysts at Kotak Institutional Equities estimate Nifty earnings to fall 30% from a year ago. Excluding banks, earnings are expected to drop as much as 47%. “In the best case, we are working at 60-70% of normal in most sectors in Q1," says Pradeep Kumar Kesavan, senior vice-president, Elara Securities.
Of course, markets world over are being driven by the liquidity unleashed by central banks, and fundamentals have taken a back seat. To that extent, a poor performance in the June quarter is likely to be ignored. But much also depends on the accompanying post-earnings commentary by company managements. For firms that are able to keep hopes alive, the stock markets will not only forgive poor past performance, but are also likely to reward the possibility of a recovery going ahead.
A case in point is Tata Consultancy Services Ltd (TCS). Quarterly performance of the country’s largest software services firm has been weak for two consecutive quarters. Operating profits have fallen 15% in the same period. But the management’s outlook of the future has been bright, and the stock is now back at its pre-covid levels.
Of course, for companies that report weak results, and also provide a dreary outlook, things are likely to be different. “Earnings growth will have to show a gradual pickup over the course of the year, and management commentary will be crucial. If the earnings are much worse than previously anticipated, then it could derail both FY21 and even FY22 earnings estimates," notes Rajiv Sharma, head of research, SBI Capital Markets. “What is discounted is that the first three quarters won’t be normal, but somewhere there is a hope that the fourth quarter will be normal, and demand will be back. But if that does not happen, then FY22 estimates could be cut," he adds.
Interestingly, TCS has been bold enough to say that it expects Q4 revenue to be flat on a year-on-year basis in constant currency, which syncs in well with the markets’ view of a recovery. As such, investors will be viewing commentary about the recovery more closely than the Q1 performance itself.
“For us to recoup the Q1 loss, we need to work at 100% levels and grow beyond that in the last quarter or so. That may not be possible this financial year, at least," says Kesavan at Elara Securities.
But investors are unfazed and are already pricing in a huge recovery in earnings for FY22.
Of course, it’s important to remember here that for some time now the Street has over-estimated earnings growth at the start of the financial year. HDFC Securities notes that Nifty earnings are estimated to decline only 2% in FY21, according to consensus estimates. “While it’s difficult to predict the near term, it remains to be seen if consensus can be right in FY21/FY22 after six consecutive years of significant over-estimation," it said in a note to clients.
As such, this year, too, downward earnings revision could be on the cards over time. But, as pointed out earlier, liquidity is driving investor sentiment, rather than fundamentals.
In this backdrop, companies that are able to sustain investor sentiment will be those who provide the markets what they’re itching to hear— “a sharp recovery is on its way". For companies whose managements are weighed down by the pandemic’s assault, their stocks will bear the brunt.