Earnings growth key for market rally

Going ahead, analysts say the key to continuity in flows into Indian markets depends to a large extent on improvement in earnings

The markets reached their highest level in 15 months on Wednesday, with the BSE Sensex hitting 28,210 levels in intra-day deals, while the Nifty50 rallied to 8,665. Both indices, however, ended the day marginally higher at 28,024 and 8,616 levels, respectively. Since the presentation of the Union Budget in February, the Sensex has rallied nearly 5,000 points, or 22 per cent, while the Nifty50 has gained 1,600 points, or 23 per cent.

Besides domestic factors, analysts attribute this up move to the positive sentiment globally as regards emerging markets, including India, where investors are buying into equities and commodities. Figures provided by EPFR Global, a provider of fund flow and asset allocation data to financial institutions globally, indicate All Emerging Markets Bond fund attracted an inflow of $4,673 million in the first half of 2016, while inflow into India — Asia ex-Japan Bond fund totalled $1,623 million during this period.

Vaibhav Sanghavi, managing director of Ambit Investment Advisors, explains: “The momentum has been led by risk-on trade globally, especially in EMs, led by exchange-traded funds. We have seen consistent flows coming in and it doesn’t look like this will abate soon. The flows are a part of developed markets versus EM trade, where European equities are getting sold into and the flows are crossing over the EMs. Investors are buying both equities and commodities.”

Analysts say the key to flows into the Indian markets depends to a large extent on improvement in earnings. Any global shock in terms of a sharp rise or fall in oil prices and the outlook for global growth could dent sentiment, they say.

“India’s long-term growth potential remains intact, yet it is difficult to predict when (any why) the EM tide will recede. If that happens, Indian equities will not have the legs to stand on – irrespective of the long-term growth – with multiples as high as they are now. The tide of liquidity will ebb and flow. Longer-term equity prices will be driven by earnings and their pace of growth,” points out Sanjay Mookim, India equity strategist at Bank of America Merrill Lynch, in a recent co-authored report with Anand Kumar.

Besides earnings, markets will also be eyeing macroeconomic events over the next three to four months, including monetary policy developments, monsoon and reforms. “Overall, things are looking good. We have been saying for some time that there is a lot of operating and financial leverage embedded into corporate earnings. Companies have been working on costs for several years. They have been working hard to pay down debt. If demand situation improves, we will see big earnings leverage from all these three moving parts. Earnings growth can be a lot stronger (25 per cent) in FY18 and FY19,” says Jan Dehn, head of research at UK-based Ashmore Investment Management.