Earnings growth critical for market rally to sustain

With US Fed hinting at a rate hike in Dec, experts say it could impact liquidity flow in market

The US Federal Reserve (US Fed) decided not to alter its key interest rates on Wednesday night (India time). This sent a wave of cheer to the Dalal Street with the BSE Sensex opening higher by 300 points on Thursday. But, the opening highs could not be sustained and the index ended the day with a gain of 266 points. With a couple of weeks to go for the September quarter earnings season, experts say liquidity alone won’t keep the market momentum on and the current rally won’t sustain if India Inc’s earnings don’t improve.

“Any investor loading up on India is doing so primarily because of liquidity. If earnings don’t improve, money may not be available easily,” Saurabh Mukherjea, CEO (institutional equities) at Ambit Capital, warns. “Consumption itself is not adequate to lift earnings, which is why I believe the market is fairly valued,” he adds. Gautam Chhaochharia, head of India research at UBS, agrees with Mukherjea. “Earnings have to improve reasonably because valuations aren’t cheap anymore.”

Since the start of the June quarter results season, data indicate that foreign institutional investors (FIIs) have started looking at pastures outside India. Since June, they have increased their allocations to markets such as Thailand and South Korea, where they were largely sellers in 2015. Also, India’s FII inflows ($3.8 billion) from June-till-date trail that of South Korea ($6 billion) and Thailand ($7.7 billion). Thailand was a close competitor with $2.8 billion FII money flowing into the country.

Chhaochharia feels that if earnings don’t brighten up in India, FIIs may continue to rebalance their Indian exposure. “While India may remain an overweight market for global investors, it could be difficult to sustain the earlier levels of inflows if earnings disappoint,” he warns. Certain macro-economic indicators such as current account deficit and fiscal deficit data have improved significantly. But now, it’s time for micro-level indicators such as earnings to add up. In the immediate term, the Street will keep an eye on whether effects of the Pay Commission payouts and monsoon play out in the forthcoming earnings season. Pankaj Pandey, head of research at ICICI Direct, too, feels that while foreign investors won’t change their stance on India, they could reduce their allocation if there isn’t steady earnings support from India Inc. “We haven’t touched the peak of earnings cycle again and we could still be 2-3 quarters away from the peak,” he cautions. For now, experts say the looming US elections are critical to gauge any change in policy stance by global investors, and will keep the situation fluid. “We will also know the strength of the festive season by then,” Pandey adds.

And, if the Fed raises rates in December, it will also possibly signal an end to cheap money and impact earnings of companies with huge forex exposure.