Indian stock market valuations may trigger short-term correction; IT, FMCG best places to hide amid a fall, says analyst

The rich valuations of the Indian stock market could trigger a near-term correction which can be used as an entry opportunity, while the current global uncertainty is likely to have a minimal impact on the Indian economy due to its unprecedented macro-financial stability, analysts said.

Over the last 12 months, midcap and smallcap indices have outperformed the Nifty 50 by 24% and 31% respectively. This outperformance is expected to continue with more aggressive bouts of sectoral rotation.

“India has a fortress balance sheet which is bullet-proof on all fronts — public finance, external account, banking system and corporate leverage. This keeps India’s growth story (macro and earnings) more durable and limits the second-order impact. Moreover, the Indian equities market has reduced dependence on overseas investors which should help ride out this period of uncertainty,” said Seshadri Sen, Head of Research And Strategist at Emkay Global Financial Services.

Sen believes the premium valuation of the Indian stock market is supported on multiple counts, including the better earnings growth quality and broadening investor base.

“The macro stability is reflected in the country risk premium collapsing by 60 bps over the last five years. Growth predictability is also better – India is enjoying a golden period of sustained earnings growth. Moreover, the quality of earnings too is better, with improved return ratios and cash flows for most sectors,” Sen said.

India’s investor base has broadened and the dependence on Foreign Portfolio Investors’ (FPI) has reduced, which also pushed up valuations. The analyst does not see that reversing soon.

“We are worried about the Nifty pushing 21x PER but we don’t expect the market to become too cheap either – the LTA of 19.9x is an attractive entry point,” he added.

Midcaps and Smallcaps

The SMIDs or small and midcaps are expected to continue to outperform but the next leg of the market is likely to be more balanced.

The relative strength of manufacturing + SMID is partly reflected in valuations, and that will bring down the levels of outperformance, according to the Emkay Global analyst.

“Moreover, mass consumption should make a comeback and that could drive earnings growth and upgrades across FMCG and value retail. The long-term trend will continue, but expect more sector rotation and inter-sector volatility, going forward,” Sen said.

Risks

Going forward, the global risk-off, political instability, and regulatory risks are key worries that could trigger a short-term sell-off in the Indian stock market. If a correction does crystallize, Sen said he would see that as an entry opportunity for longer-term investors.

According to him, the best places to hide from a possible correction are IT and FMCG, despite the elevated valuations, as he believes these sectors would correct less than manufacturing and cyclicals.

Disclaimer: The views and recommendations made above are those of individual analysts or broking companies, and not of Mint. We advise investors to check with certified experts before making any investment decisions.