Earnings outlook to remain bright

Indian stock indices are trading near their all-time highs and it is probably a good time to chart out an outlook for the future and compare it with the situation three years ago. Equity valuations were richer in 2007, with market cap to GDP ratio at 1.5 as against one.

This rally has been relatively narrow than in 2007. The reform scenario has been stronger in 2010, with several government initiatives in fertiliser, telecom and oil & gas sectors. The overall economic growth indicators are at similar levels but consumption trends are stronger now. Utilities, realty and energy did well in 2007 while in 2010, they were amongst the worst sectors. Consumer discretionary, healthcare and IT were laggards in 2007, but performed now. Recent equity MF redemption indicates that domestic institutions (DIIs) are selling, while FIIs and DIIs were buyers then.

While there are similarities with 2007, particularly in the overall growth numbers, the difference in terms of valuations, investor behavior and state of country’s balance sheet is significant.

Indian economy is delivering strong growth and the trajectory is expected to accelerate rather than slow down. Over the last year, the market has delivered 20-plus per cent and the earnings growth have been similar. While the markets may be near all-time highs, valuations based on price to earnings multiples are similar to same period last year. Though the valuations may be higher than the average valuations seen in the past years, they have sustained at these levels for some time.

The high liquidity in the system and low interest rates in global context explains the high valuations. This also explains, in part, the FII buying and DII selling behaviors. We expect that FIIs could continue to invest given that the scenario of cheap money would stay over the next year and the predicted direction of the currency movements (weakening USD) would support assets like emerging equity. We also expect the retail investor to return with the return of stability in the markets and profits from participation in public issues like Coal India. The markets should be able to absorb the flows, with supply of paper remaining strong, supported by expected fall in domestic inflation reducing the pressure on monetary policy.

Except for liquidity issues like in 2008, we believe that Indian markets can sustain high valuation.

The outlook on earnings remain strong and over the next one year earnings may move up by over 20 per cent on the index. The chance of the market behaviour repeating CY10 learning is high. We expect the Indices to deliver slightly less than earnings growth but in excess of other investment categories with valuations correcting towards averages.

The author is head, equity, Bharti AXA Investment Managers. Views are personal.