Stocks may be rallying, but analysts see major risk-reward mismatch
The market is at elevated valuation on all counts, said Vinod Karki of ICICI Securities.
To be sure, brokerages are not worried about the election outcome, which could at best draw knee-jerk reaction. What they are worried about is continuous earnings downgrades, cautious management commentaries and weakening macro data, which suggest the domestic economy is slowing down.
This could be a big headache for the next government after May 23.
Data prints suggest India’s factory output contracted 0.1 per cent in March, its lowest in 21 months, thanks to weakening manufacturing activity. In spite of talks of possible gains that India may see from rising US-China trade tensions, the country’s April merchandise export fell to a four-month low, while imports hit at a six-month high, widening trade deficit for the month to $15.33 billion.
Services activity expanded in April but was at a seven-month low, as suggested by Nikkei India Services Purchasing Managers' Index (PMI). Auto sales, a gauge of consumer sentiment, fell 16 per cent last month, which was the worst in eight years.
Consumer price inflation climbed to 2.92 per cent in April. And going by IMD, there is already a slight delay in the arrival of southwest monsoon on Kerala coast this year. Consumer companies have already sounded caution, so do analysts.
Worse, there is limited space for fiscal stimulus.
“The government’s fiscal position is stretched, given the risk to revenue collection in the backdrop of a slowing economy. Any significant rise in off-budget expenses on infrastructure and regular slippage on the fiscal front by the state governments would present a challenge,” said Nomura India.
Historical data on government expenditure growth suggests central government’s expenditure growth slows in the year following a general election. “We see a downside risk to expenditure growth, as the new government is likely to focus on fiscal consolidation in the initial period of its tenure,” Nomura said.
The brokerage does not see a major reversal in current weak economic conditions, even if NDA returns with a clear majority.
On the earnings front, there is not much to write home about. Meanwhile, two-thirds of Nifty returns since February 19 low has been anchored by just 10 stocks. This, UBS said, suggests anxiety around the election outcome. This could also possibly be due to fundamentals, it said.
Kotak Institutional Equities said a significant portion of the correction in the largecaps of late has been due to earnings downgrades rather than correction in multiples. “Valuations of Indian stocks are not cheap despite muted performance of the broader market and a severe correction in several sectors and midcaps.”
The market is at elevated valuation on all counts, said Vinod Karki of ICICI Securities. “On top of that, high frequency data suggests we are undergoing some kind of a slowdown. The earnings downgrade cycle continues. There is no space for material earnings upgrade, which has typically been the foundation of a bullish market,” Kakri said, adding that the market is not in a favourable risk-reward situation,” he said.
UBS said the risk-reward is unfavourable, looking beyond the immediate market moves.
At present, Nifty trades at 20 times 12-month forward PE.
Gautam Duggad, Head of Research at Motilal Oswal Securities, said earnings have been in line so far, but the problem lies with downward earnings revisions. “The upgrade-to-downgrade ratio is pretty poor. Earnings have been downgraded by more than 3 per cent for about 36 companies, and upgraded for only 20. Clearly the future direction of earnings is still showing a downgrade. More importantly, management commentaries have been quite sombre, Duggad told ET Now.