Market looks for credible road map from new govt

Macro factors will prevent a sharp rise in growth. Strategists recommend banks and energy stocks

The markets have got what they were rooting for — a stable government helmed by Narendra Modi. Since the ‘hope rally’ began in February, the Sensex has zoomed 20 per cent and the market's multiples have risen sharply in the last few months. The Sensex is currently trading at 15.9x its FY15 earnings, which is higher than the 10-year average of 14.2x. India is trading at a 35 per cent premium to the MSCI Asia-ex-Japan Index. Given that nothing has fundamentally changed, sustaining premium valuations will be tough. For that to happen, investors will want the government to articulate its economic agenda quickly.  

Markets are impatient and the next trigger will be news-driven. While the onset of the monsoon will be keenly watched, given the fears of El Niño, the first thing investors will watch out for is the constitution of the Cabinet and allocation of key portfolios. Credit Suisse, which expects key portfolios will likely be allocated by May 27-28, believes reform prospects in the 12-15 economically important ministries would depend on the minister/party that gets them. The market will want the government to demonstrate its commitment to macroeconomic stability and fiscal consolidation. HSBC Global Research expects the Budget to emphasise developmental spending over recurrent expenditure.

Sustaining India's 'Goldilocks' status is possible only if earnings upgrades happen. This looks unlikely, given the composition of the index and the earnings profile of index heavyweights. According to Kotak Institutional Equities, about 60 per cent of the profits of the BSE-30 Index or of the Nifty-50 Index come from outsourcing (IT, pharmaceuticals and parts of the auto sector), commodity (metals and private oil & gas companies), regulated (power utilities) and government-controlled (PSU oil & gas and Coal India) sectors.  

For premium valuations to sustain, earnings upgrades have to happen and for corporate earnings to pick up, growth has to pick up from sub-five per cent levels. If the monsoon plays truant this year, even five per cent growth will be at risk. Given the fiscal situation and inflationary pressures, the new government is unlikely to give a stimulus of any kind. Given that macroeconomic challenges will take time to resolve, earnings upgrades are unlikely. Kotak Institutional Equities expects banking and PSU energy sectors may see upgrades, driven by lower credit costs and subsidies. "We do not find great value in other parts of the market barring in IT."