Resilient earnings give equities solace as RBI goes full throttle on rate hikes

The surprising inter-meeting hike in interest rate announced by the Monetary Policy Committee of the Reserve Bank of India on May 4 left domestic equities scrambling to recalibrate their expectations of how fast the rate-setting panel will raise rates going ahead.

The 40-basis-point hike in interest rate caught investors off-guard causing a meltdown in benchmark equity indices, which closed more than 2 percent lower on May 4.

Economists now expect the central bank to raise the repo rate by as much as 210 basis points to as high 6.5 percent by the end of 2023 as it looks to reign in surging domestic inflation.

“There is the collateral risk that if inflation remains elevated at these levels for too long, it can de-anchor inflation expectations which, in turn, can become self-fulfilling and detrimental to growth and financial stability,” RBI Governor Shaktikanta Das said in his statement on May 4 following an emergency rate-setting meeting on May 2-4.

“Hence, we must remain in readiness to use all policy levers to preserve macroeconomic and financial stability while enhancing the economy’s resilience,” the governor added.

Brokerage firm Goldman Sachs said in a note that it now expects the MPC to raise the repo rate by 50 bps at the June meeting followed by 25 bps each in the August, October and December meetings.

Also Read: Bankers surprised at timing, quantum of RBI rate hike

Rising interest rates to tackle persistently high inflation (retail inflation touched 7 percent in March) combined with a hike in cash reserve ratio to drain out a portion of the excess liquidity in the banking system is seen as a major risk for equity market, which have partially benefitted from the central bank’s accommodative policy for the better part of three years.

Further, rising domestic and global bond yields as a result of factoring an aggressively hawkish central bank policy around the world will force investors to be more circumspect on ascribing generous valuations to companies and thereby, compressing overall valuation of the market.

That being said, with two out of the three pillars (retail inflows and accommodative RBI) of the COVID-19 bull market now fading, the responsibility of driving the market will solely rest on corporate earnings.

Resilient Earnings

 The current inflationary environment is being driven by soaring global commodity prices due to years of supply-side underinvestment and sanctions on one of the largest commodity producers Russia. Coupled with supply chain issues caused by the pandemic, rising commodity prices have become a bane for the profitability of companies that consume commodities while boosting earnings of those who produce them.

Brokerage firm ICICI Securities said that the March quarter results so far indicate the mean reversion of aggregate corporate profits, which began from the decadal low point in 2019-20, is intact. The corporate profits-to-GDP ratio, a key indicator of corporate health, has risen to 4.3 percent on a trailing 12-month basis after incorporating earnings of 230 companies that have reported results so far.

ICICI Securities also noted that more companies have beaten the market’s expectations on earnings than missed them as far as March quarter results are concerned despite the initial wave of earnings being dominated by consumers of commodities and the services sector.

“Most commodity producers are yet to announce results, especially from the oil & gas sector, and could likely tilt the scale further in favour of more beats than misses going ahead,” ICICI Securities said.

Motilal Oswal Financial Services expects earnings of Nifty 50 companies to grow 35 percent in 2021-22 and 19 percent in 2022-23 as the domestic economy continues its incipient recovery from the ravages of the pandemic.

“Despite the frightening news emanating from the Russia-Ukraine warfront, US Fed rate hike, tightening liquidity, and supply chain disruptions, the market has remained resilient backed by very strong corporate earnings, which matters the most to market returns in the long term,” Motilal Oswal Financial said in a note.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 taking any investment decisions.