Earnings downgrades a drag on the market

Consensus earnings estimates for the Sensex stocks down by 0.3 per cent over the past month, SBI, DLF & Cairn see most downgrades

Markets tend to dance to the tune of earnings. Consensus earnings upgrades can help even the least-preferred stock in the benchmark spike on any day, just as a downgrade can trigger a selloff. The past week saw many such knee-jerk reactions, especially in banking, largely driven by earnings expectations from index heavyweights.

In the past month, analysts have downgraded the FY15 earnings estimates of three key companies — State Bank of India, DLF and Cairn. While the downward revisions are in double-digits, the upward revisions for three key stocks — Bharti Airtel, Tata Motors and Infosys — are largely in single digit. After the downgrades, the consolidated FY15 consensus earnings estimates for the Sensex stocks have decreased by 0.3 per cent over the past month, says Nomura.

While the market was cutting earnings estimates, the benchmark continued to rise in January by 6.4 per cent (from 27,506 on December 23, 2014, to 29,279 on January 23, 2015). The brokerage says the market’s earnings multiple rose to 16.37 times versus 15.74 times a month before, making it 8.1 per cent more expensive than its five-year average.

In January, the Sensex rose eight per cent to an all-time high of 29,682. After forming a top in January, the markets have been in search of such negatives to correct the liquidity-driven rally. The week saw some of this needed correction, with the Sensex falling three per cent to 28,883. Analysts believe another couple of percentage points is likely, as the top 30 Sensex companies are unlikely to report double-digit earnings growth.

Financials are continuing to show stress and consumption is not showing any sign of revival. Goldman Sachs has turned cautious on financials as recovery still seems some time away. Analysts expect private banks to report a compounded annual earnings growth of 17-20 per cent over FY15-17. While the long-term story remains intact, the short term is proving a challenge for the markets.

Nitin Jain, president, global asset management and capital markets at Edelweiss, believes the clean-up had to happen after the markets hit a new high in January. “After forming a top in January, the market was beginning to appear stretched in the face of the earnings trend,” he said.

Clearly, it isn’t easy to justify a hefty premium for Indian equities when earnings are growing in single digit. There’s just that much premium hope can command. The Street and equity strategists are expecting the government to come up with major reforms in the Union Budget to be presented on February 28 for the new financial year. The equities team at Credit Suisse says: “While the market worries about acute fiscal stress in FY15, we believe the government can raise capex by at least 1.2 per cent of GDP in FY16. It is pocketing a large part of the gains from the oil price decline and can spend to generate growth: Counter-cyclical pump-priming.”