Amid war and volatility, India’s stock market finds earnings candle

The fourth quarter of FY22 has been eventful for equity markets globally as an unexpected eruption of a war, soaring prices of commodities and a tapering of easy money policies by central banks kept investors on edge. It wouldn’t be a stretch to expect investors growing sceptical on the outlook and getting out of their equity investments, especially in emerging market economies such as India that are on the receiving end of volatility.

Indeed, the volatility index, India VIX, has spiked 28 percent during the current quarter while the benchmark Nifty 50 index remained largely flat.

But, stranger things happen in markets. Earnings per share (EPS) estimates of Nifty50 companies have been raised, led by key sectors such as banks and commodities. EPS estimates rose 5.8 percent in the current quarter, Bloomberg data showed. For the 30-stock BSE Sensex, the EPS target rose by 4.55 percent. What gives?

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A stronger-than-expected performance by banks in the December quarter, faster vaccination coverage and receding covid-19 infections, and a pick-up in high-frequency economic data have given confidence to analysts on full-year earnings.

“Banks, especially large ones, had posted strong results in the third quarter of FY22 which would have raised analysts’ confidence in the future earnings trajectory. Besides, a continuous rise in metal prices would have resulted in raised earnings estimates for the sector. Additionally, a short third wave and faster unlocking would have helped to raise estimates for some of the consumption-driven companies,” said Ajit Mishra of Religare Broking.

Deepak Jasani, head of retail research at HDFC Securities, pointed out that banks have reported a smart recovery in credit growth and a reduction in stressed assets, which augurs well for their earnings. Further, commodity prices have risen sharply, benefiting integrated companies that stand to benefit from a rise in prices.

That said, valuations of India’s equity market have fallen this year. The Nifty and Sensex are trading at 19.86 times and 21.28 times their respective one-year forward price-to-earnings (PE) ratio, down 85 basis points and 78 bps from December, respectively. The Nifty’s one-year forward PE is at a premium of 122 bps versus its five year average of 18.65 times.

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This compares with MSCI World’s valuation multiple of 17.7 times one-year forward PE and that of MSCI Emerging Markets at 11.91 times. “Valuations of Indian markets have fallen of late but it still trades at a premium to MSCI EM. Uncertainties arising out of the latest headwinds including war, inflation, interest rates, possibilities of carry trade unwinding (reflected in foreign portfolio investor outflow numbers) and supply disruption have led to this de-rating,” said Jasani.

Analysts believe that the pressure on valuations may remain as the global sentiment is turning hostile from a demand, liquidity and prices standpoint. India, so far, has benefited through stronger exports, ample liquidity and a rally in stock prices. Of these, the outlook on exports is unclear and liquidity is expected to reduce as the Reserve Bank of India (RBI) continues on its withdrawal track. Forecasters have already begun to trim their economic growth expectations amid uncomfortable inflation numbers.