Indian markets have seen a 200 basis point de-rating in the price-to-earnings ratio. The trend of contraction in PE multiples and earnings consolidation are likely to keep the markets rangebound for some time, Sahil Kapoor, market strategist and head of products at DSP Investment Managers, said in an interview to Moneycontrol.
The Indian markets are trading slightly above their long-term valuations, although not in the expensive zone, he said. While the markets have discounted a large part of the pressures from the recent rise in commodity prices, there could be more pressure on growth if oil prices persist beyond $125 a barrel and this could lead to further corrections, he said. Edited excerpts:
Are Indian market valuations still expensive and will the expected change in the Reserve Bank of India’s stance put pressure on valuations?
There are multiple headwinds ahead: the US Fed is likely to raise rates, the RBI is expected to normalise interest rates upwards, corporate India is likely to adjust its margins in response to input price pressures, and then there is geopolitical disturbance.
The Indian markets have seen a 200 basis point de-rating in this PE (price-to-earnings) ratio. This trend of contraction in PE multiples and consolidation in earnings is likely to make Indian markets rangebound for some time. The Indian markets are trading slightly above their long-term valuations, although not in an expensive zone.
Do you expect a further cut in the full-year growth forecast?
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For now, it appears that India can clock above 7 percent growth in FY23. The risk from higher oil prices and high interest rates are the key factors to watch. Both these factors can derail the budding recovery in the Indian economy.
For every $10 rise in crude oil prices from $100 a barrel, nearly 10 bps of incremental growth can get shaved off over a 12-month period. However, a resolution of the Russia-Ukraine crisis and the easing of oil prices can have a commensurate positive impact for India.
Are the Indian markets worried about inflation? Has earnings weakness on higher inflation been priced in? Will that bring the markets sharply down?
There are signs of raw material price increases eating into margins. The commentary from consumer staple companies is of caution due to slower volumes, rising input costs, and margin pressures due to downtrading. This impact was beginning to become more pronounced after the geopolitical conflict started in February. We expect this to play out over the next two to three quarters.
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Most of these stocks reflect these expectations in their performance. As per our estimates, if oil remains in the range of $100 to $110, India will scrape through with minor adjustments. In case oil prices persist beyond $125, India is likely to see more pressure on growth and its external situation. This can lead to further corrections. As of now, we believe the markets have discounted a large part of the current price pressures from the recent commodity price uptick.
Will the Fed rate trajectory impact the IT space even as it has a healthy orderbook? Is it time to be cautious in this space?
India’s IT space is likely to see some consolidation, largely on the back of slower growth in the western markets. Although the commentary and earnings trajectory remain robust, there is a possibility of valuations taking some beating after the stellar run in the last two years. There could be more consolidation in this space ahead.
Are higher valuations than Asian counterparts the only and major reason behind foreign institutional investor outflow?
Firstly, the emerging markets basket has seen substantial selling from FIIs. India being part of this basket with around 9 percent weight gets its fair share of outflows, which are commensurate with the EM basket. Secondly, earnings growth in India has slowed versus the last two financial years. FIIs usually follow the earnings cycle.
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In addition to these points, India was trading at a record premium to its EM peers, which also led to some reduction in India’s weightage in some active funds. However, the reasons for FIIs to sell now are less and it’s possible that the majority of FII selling is behind us.
Has the Fed rate trajectory been priced in by the market?
The markets are expecting sharper rate hikes from the US Fed. The Fed Fund Futures market is indicating a probability of a 50 bps hike in the May Fed policy. The Fed wants to normalise rates quickly. It’s quite possible that the Fed may review the pace and magnitude of rate hikes after the May meeting, depending on how growth unfolds in the US.
Are you betting on commodity-linked sectors?
Commodity-linked sectors are enjoying high valuations and positive sentiment. This is built on a case for very strong earnings growth continuing for a larger time period. As of now, one should remain cautious in this sector as it requires many extraordinary things to continue to remain that way.
Disclaimer: The views and investment tips expressed by investment experts on Moneycontrol.com are their own and not those of the website or its management. Moneycontrol.com advises users to check with certified experts before making any investment decisions.
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