Earnings downgrades likely

The markets have witnessed extreme volatility in the past two months and particularly over the past few weeks, with the Nifty moving by 700-1,000 points over 20-25 days .More, the Index hardly reflects the state of the broader market, which in any case has been moribund for a long period of time. The markets have become extremely narrow and interest appears limited to a few stocks only.

Broadly speaking, the Index has been gyrating at 5,400-6,100 for several months.

This perhaps, reflects the confusion in the minds of investors regarding the state of the Indian economy and global developments. The US Federal Reserve has not helped by vacillating on the tapering issue. In India, the government appears to be taking some steps on the ground to enable stuck projects to take off, but with the political uncertainty due to elections, the market perhaps needs more evidence on the ground to be certain that the economy is going to improve going forward. Moreover, high inflation and a looming fiscal deficit problem can still act as a brake on higher growth rates. The current account deficit problem, however, is probably being gradually brought under control.

Consequently, the wild volatility of the currency is likely to subside and the rupee is likely to settle down in the range between 60 and 64 to the dollar. However, any increase in the global value of the dollar due to US tapering could again be a reason for rupee volatility.

We believe that interest rates are likely to remain elevated for at least a few months as inflation is unlikely to taper down significantly and as the RBI follows a tight monetary policy to rein in the inflation dragon. This, together with uncertainty of the fiscal deficit front is likely to keep 10-year bond yields to remain high between 8.5 and 9 per cent. State Elections in November/December' 2013, would also have a significant impact on sentiment. Emerging markets in general will continue to face risk on/risk off phases depending on developments in the US.

With the corporate reporting season around the corner, investors' focus would shift to the performance of various companies and sectors during October and early November. The market seems to be factoring in an earnings growth of 10-12 per cent in FY2014.

However, weak performance in the first quarter is likely to continue during the July - September period, as high interest rates, rupee depreciation and generally weak demand would continue to put pressure on the revenue, margins and the profit of the corporate sector.

Except for technology, pharma and few select fast-moving consumer goods companies and a few private banks, performance at large is likely to be even worse than the first quarter.

While the third and fourth quarters could be somewhat better due to a good monsoon and likely spending due to Elections, overall earnings growth during FY2014 is unlikely to exceed six to seven per cent. This implies a risk of earnings downgrades over the next few months. This, together with reasonably expensive valuations would keep the markets under pressure.

Given the above, we expect the markets to remain volatile over the next couple of months, with a downward bias, but on balance the Nifty is likely to continue to trade largely in the 5,400 - 6,100 range.

The author is group CIO, IL&FS Ltd