Indian Markets May Move In A Range Seeking Consolidation

The Indian equity market has weathered adverse global and domestic developments (Greece debt crisis, weak corporate earnings, sub-optimal monsoon forecast) and continued to consolidate in a broad range of 500 odd Nifty points. With the global environment likely to remain unfavourable and no re-rating trigger domestically, the consolidation phase could extend further.

Locally, the market would have to climb the wall of worries emerging from another quarter of weak corporate earnings and the possibility of a policy logjam with a disruption of the monsoon session of the Parliament and further delays in the passage of critical bills like the Goods & Services Tax (GST) Bill and the Land Acquisition Bill. Though the onset of the monsoon was better than expected, July is critical in terms of both volume and spatial distribution of the rains from agri-output perspective. The Reserve Bank of India (RBI) is also keenly watching the progress of the monsoon and the government’s policy action as well as the emerging global situation before moving ahead with the easing of its monetary policy.

Though the situation in Greece and Europe, and its fall-out on the global financial system remain uncertain, the market is looking at the silver lining in the form of a further postponement of the rate hikes in the USA and a decline in energy prices. We believe that such assumptions are fraught with risk. Moreover, China could emerge as a pain point as is apparent from the unrelenting rout in the Chinese equity market in spite of the steps taken by the government to calm the nerves of investors.

In the upcoming result season (Q1FY2016), corporates may deliver an earnings growth (as against an earnings decline seen in the previous couple of quarters) and the growth may pick up momentum going ahead. The earnings growth would be led by a sharp increase in government spending (in power, road, railways and renewable energy sectors), an economic recovery and an expansion of the operating profit margins (owing to lower input cost, operating leverage). Though a 20% compounded annual growth in the consensus earnings (of the BSE-100 companies) may look stretched given the backdrop of the disappointing results in the previous two quarters, we believe that the final figure could be in high double digits. The bulk of the incremental growth in the earnings over the next two years is expected to be driven by five key sectors: cyclicals (financial services, auto), energy, select engineering companies, information technology (IT) services and pharmaceuticals (pharma).

The benchmark indices have outperformed the global peers in the past couple of months, thereby pricing some of the global and domestic issues. In spite of a sharp downgrade in the earnings over the past couple of quarters, the Sensex trades at 14x FY2017E earnings. Also the MSCI India Index premium over MSCI Emerging Markets Index has shrunk to 25% vs a mean of 36% which suggests that the risk/reward ratio is favourable for investments with a time horizon of 18-24 months.

While the consolidation phase (volatility with a negative bias) could extend by a few months (due to global issues, delay in reforms), it provides an excellent opportunity for investors to accumulate the quality plays from some of the segments that we have been highlighting, such as cyclicals (private banks, auto), urban discretionary consumption plays and select stocks within the industrial and pharma sectors.