MC Interview: Promising outlook for Indian markets, focus on quality stocks, says Sharekhan's Gaurav Dua

In Q1 (Apr-June quarter), Nifty earnings would get a big push from the surge in profits of oil marketing companies

In a recent interview Gaurav Dua, Sr VP & Head – Capital Market Strategy, Sharekhan by BNP Paribas said the outlook for the Indian markets in the medium to long term is highly promising, primarily due to the ongoing multi-year economic growth cycle and the anticipated robust growth in corporate profits over the coming years.

From an investor's standpoint, it is advisable to refrain from chasing momentum and speculative stocks at their current levels. However, it is prudent to remain invested in high-quality stocks. In fact, any volatility or market pullback should be viewed as an opportunity to carefully accumulate selectively chosen stocks at more favorable entry levels, Dua added. Edited excerpts:

What is your take on markets? Should investors exit at this time, or remain invested?

Markets never fail to surprise. Benchmark indices have climbed the wall of worries and practically made a new high almost everyday in the past couple of weeks. Post the recent rally, Nifty trades at 19.5-20x one year forward earnings which is at premium to long term average and not cheap anymore. However, the outlook on the medium to long term remains extremely attractive given the multi-year economic growth cycle and the expected healthy growth in corporate profits over the next few years. From an investor's perspective, one needs to avoid chasing momentum and speculative stocks at current levels. But can stay invested in good quality stocks. In fact, any volatile or pullback should be used to accumulate carefully short-listed stocks at better entry levels.

Are valuations rich or expensive given the underlying earnings and growth estimate?

As mentioned above, Nifty trades at around 10% premium to long term average valuation multiples now and not cheap anymore. However, one needs to understand that valuations are nowhere close to all time high though the Nifty/Sensex index is at new high. That’s because the markets have gone through time correction for almost 20 months and consolidated in the 16,000-18,000 range on Nifty while corporate earnings have gone up by close to 25% in the same period. Also, as an investor, we need to focus on opportunity in individual stocks rather than worry too much about valuation at index level.

Any sectors/stocks where valuations are very rich?

We see pockets of stretched valuation in some of the stocks in engineering, consumer discretionary, financials, real estate among others. Also, the recent surge in the broader markets has resulted in some of the stocks running ahead of their fundamentals; especially in the microcap space which is reflected in close to 34% appreciation in CNX Microcap 250 index in the past three months alone.

What are the downside risks?

After a strong rally, the markets can always pullback by 5-8% from the recent peak which would be a healthy correction. We expect the reason for the correction to come largely from global uncertainties rather than domestic issues. Globally, the H2 would see a more pronounced impact of rate hikes on economies in the developed markets. Plus, the geo-political issues continue to be an overhang.

Which are the sectors/stocks which will continue to do well?

If an investor has at least 18-24 month of investment horizon, our preferred picks would be banks, building material, cap goods/industrials and consumer companies. We also see value emerging in underperforming sectors like pharma and IT services. Though it is difficult to call out an exact bottom in these two sectors, we believe that a lot of negatives are priced in and any surprise in terms of growth and margins could lead to substantial re-rating here.

Will the movement of the rupee weigh on the FII investments in India?

FII inflows have been very strong in India lately. Though the FII flows tend to be very volatile and unpredictable, we believe that FII flows continue to remain on the positive side in H2 of CY2023 also. On a trailing twelve months basis, FII flows have only turned positive in May 2023 since December 2021 – gap of almost 19 months. Generally, the change in trend over a 12 month trailing basis is sustainable for a 6-12 month period.

Are the underlying fundamentals supporting the rally?

The rally has been supported by both surprises on the fundamental side in terms of Q4 FY2023 GDP growth, Q1 FY 2024 corporate earnings and other high frequency macro data points. Globally also, the equity markets have done well in H1 of CY2023. Technically, the market has also got strong support from continued retail SIP inflows in mutual funds and reversal in trend of FII inflows since April this year.

What kind of earnings growth is expected in the April to June quarter?

In Q1 (Apr-June quarter), Nifty earnings would get a big push from the surge in profits of oil marketing companies (OMCs). We expect OMCs to report Rs40,000 crore of combined profits in Q1 FY2024 as compared to net loss of Rs18,500 crore in Q1FY2023. This would provide an alpha of close to Rs58,500 crore to corporate earnings in Q1 result season. Also, the banking and auto sector would push the Nifty companies combined profits growth to around 20% in April-June quarter.