‘All is not that well’, say market experts even as stocks chase new highs

• India’s benchmark indices Nifty50 and Sensex have rallied between 3.5-3.8% in the last one month.
• However, according to a new report by Kotak Institutional Equities, the markets chasing new all-time highs could be illusory.
• From medium-term challenges like uneven growth across sectors to the impact of Covid-19 on household incomes and balance sheets of low-income households, the Indian economy and earnings story has a few hurdles to cross.
• Despite these challenges, analysts at Morgan Stanley say this could be India’s decade and catapult it to the third-largest economy by 2030.

India’s benchmark indices Nifty50 and Sensex have rallied between 3.5-3.8% in the last one month, wiping out the entire year-to-date decline in 2022 so far. Sensex hit a new all-time high earlier this week, while Nifty50 kept up its chase with the index making its third-highest closing.

However, according to a new report by Kotak Institutional Equities, the markets chasing new all-time highs could be illusory. While the current bull run suggests that the Indian economy and earnings are on the right track, there are a few hurdles in the path.

“The Indian market’s rich valuations and relatively strong performance in the past few months would suggest that market participants are very optimistic about India’s short- and medium-term outlook. However, the market may be overlooking several short- and medium-term challenges to growth and inflation both,” said the Kotak report.

For context, the Indian markets have posted a strong bounce back, gaining between 18.7-19.2% since June 15.


Source: Morningstar, as on November 18, 2022

According to Dhananjay Sinha, head of strategy research and chief economist, J M Financial, Nifty50’s trailing 12-month PE is around 22x, which is at a premium of 18-20% over the long period average (LPA).

“At trailing 12-month PE of around 22x, Nifty50 remains expensive despite the rise in risk-free rate of return, earnings and GDP growth rate downgrades,” Sinha told Business Insider India.

The Kotak report has also outlined a few other issues which point at a story that is different from what the market performance suggests.

‘Market says all is well; data shows all is not that well’

According to Kotak, the Indian economy and earnings growth has not been as robust as it is generally perceived, suggesting that all is not well, yet.

“The June quarter GDP data was quite disappointing when viewed on a 3-year CAGR basis with private consumption growing at 3.2% CAGR only,” the report stated. India’s real GDP growth came in at 13.5% in Q1 FY23 at a 3-year compounded annual growth rate (CAGR) of 1.3%.

Consumption, on the other hand, grew at a 3-year CAGR of just 3.2%, which is the second slowest in the past nine quarters.

The Kotak report adds that this is due to the combination of the large negative impact of Covid-19 on the incomes and balance sheets of low-income households, as well as persistent high inflation, which hit a high of 7.79% in April this year.

Limited scope for earnings upgrades

While the Q2 FY23 earnings beat the expectations of the research firm, it notes that the scope for earnings upgrade is limited in the medium term.

“We see limited scope of earnings upgrades given the backdrop of weaker-than-expected domestic economic recovery, a slowdown or recession in developed market countries and higher-than-expected interest rates, which may affect demand,” the report stated.

Overall, the firm says that it expects Nifty50 earnings to grow at 11% in FY23 and 16% in FY24. However, it notes that earnings of sectors like metals, and oil & gas may not grow as fast as other sectors.

Entrenched inflation a risk going forward

Central banks around the world have hiked interest rates to tame inflation, but the rate hike cycle has not come to an end yet due to persistently high inflation.

“The market now expects peak US Fed Funds rate at 5% by early 2023, which is much higher than its earlier expectations,” said the report.

As far as India is concerned, RBI has hiked interest rates by 190 basis points to 5.9%, but the inflation has remained above the central bank’s upper tolerance limit of 6%.

The Kotak report notes that India faces the risk of entrenched inflation going forward due to high domestic food prices, and global fuel prices.

‘India’s decade’, say analysts at Morgan Stanley

Despite the economic and earnings challenges in the medium term, analysts at Morgan Stanley say this is “India’s decade”.

“India has the conditions in place for an economic boom fueled by offshoring, investment in manufacturing, the energy transition, and the country's advanced digital infrastructure,” said a report by Morgan Stanley.

It also added that India is on track to become the world’s third-largest economy and stock market before 2030.

“The rise in India's GDP will be very similar to China's trajectory over 2007-11,” the report stated, adding that India could be an above $7.5 trillion economy.

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