Brokerages are advising investors to be cautious about India's relatively strong macroeconomic position, as recent developments have raised concerns.
Jefferies India, for instance, recently highlighted that increasing crude oil prices, progress in China's equities market, and domestic inflation worries are expected to continue to weigh on the Indian equity markets in the near future. On a similar note, Kotak Institutional Equities mentioned that escalating food prices, the rise in crude oil costs, sluggish tax collections, and persistent inflation are expected to contribute to continued challenges.
"Goldilock position for Indian equities is getting questioned with crude rallying, China gaining some traction, rising India CPI and yields moving up," said Jefferies India in a recent note.
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Nifty rallied a strong 18 percent from its March lows, when analysts turned bullish on the markets, reaching new all-time highs near the landmark 20,000 mark by Mid July. However, foreign Portfolio Investors (FPIs) have turned into net sellers recently, and India's performance relative to the MSCI Emerging Markets has lagged behind by 3.2 percentage points in the last month.
Despite the short-term outlook being subdued, there are increasing indications of a rise in capital expenditures. Jefferies maintains a preference for domestic cyclical sectors like financials, industrials, and property, along with mid-cap stocks. In their model portfolio, Jefferies has shifted 3 percentage points from Reliance Industries (RIL) to banks.
The Nifty, post the rally, is trading at 19x 1-yr forward PE; up 12 percent since March lows and 11 percent above the 10-year average. "On our preferred yield-gap parameter (10-yr bond yields less 1/Nifty PE), the gap at 193bps is +52bps since March lows and +62 bps above average, pointing towards stretched valuation," the Jefferies report added.
Nevertheless, in comparison to the EM and AxJ benchmarks, relative valuations remain within average ranges. Consequently, the potential for significant underperformance in India seems restricted. Jefferies India holds the perspective that Indian equities are expected to experience a period of range-bound movement in the near term before the occurrence of the subsequent rally.
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"Rich valuations in the case of most sectors leave little room for disappointment. We see short-term risks from weaker-than-assumed macro-economic conditions that may keep interest rates at elevated levels and hamper domestic economic recovery and consumption and weak global economic conditions that may impede recovery in the export-oriented (outsourcing) sectors," Kotak report added.
Most consumption companies saw strong improvement in profitability in the first quarter of FY24 following the improvement seen in the second half of FY23. The expected improvement in profitability due to a decline in raw material prices was one of the primary reasons for the run-up in the stock prices of consumption stocks.
However, Kotak points out that consumption sector volumes remain subdued, while raw material prices are beginning to rise once more, driven by a substantial surge in crude oil prices. The elevated valuations of consumption stocks suggest the expectation of prolonged high growth and profitability.
"We have serious doubts about the high profitability of companies sustaining beyond the next 1-3 years given the ongoing and forthcoming disruption to business models and erosion of business moats," said Kotak in its 8 August note.
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