The recent rally in the Nifty, which is close to 12 per cent from end-February lows, is mostly a result of external factors such as depreciation of the dollar and improvements in emerging markets' indices, combined with strength in the commodity complex. All these have together helped improve sentiment for the market.
The consensus bottom-up forecasts of close to a 17 per cent year-on-year (y-o-y) profit after tax growth in FY17 appear high. Market earnings over the past two years have already been hurt by large declines at commodity (oil and metal) company profits. These should not ideally recur due to the low base, and also because commodity prices have started moving up. The risk to earnings can now emanate from continued asset quality stresses at banks and from the deflation / disinflationary risks to top lines across sectors. Index earnings, in a top-down approach, are expected to grow 12-13 per cent year-on-year in FY17.
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Companies under Bank of America Merrill Lynch research coverage have so far delivered mixed results for the March quarter. Banks have in general delivered numbers weaker than forecast. Non-banking companies have largely beat expectations while many companies are yet to report numbers. The risk remains that the results in the second half of the quarter are generally weaker than initial trends. The ongoing results season might not, therefore, mark the inflection in earnings delivery that investors are keenly awaiting.
Headline index price-to-earnings multiples are now at or above 20/15/10 year averages, leaving little room for valuations to independently expand further, owing to the tepid local earnings growth. The movement of the Indian equity market can, therefore, remain highly dependent on global cues in the near term. These can be difficult to predict.
Any change in the perception of global central bank positions can create meaningful volatility. The current consensus - US dollar weakness leading to emerging market strength - is at risk to any hawkish comments from the American central bank, reaffirming current expectations of a rate hike in June. Attempts by the Bank of Japan to reverse the ongoing appreciation of the yen could impact the outlook for other exporting countries. A resurgence of growth and debt concerns in China can lead to a broad-based outflow of money from emerging markets. We see limited upside to Indian equity markets hereon and retain our year-end Sensex target of 26,000.
Even though global financial markets are currently highly correlated, the medium-term economic performance of countries will likely be differentiated. In the absence of a global demand-led rising tide, specific economic situations and efforts by local policy makers will be the key determinants of progress. India is well placed on both counts. Indian consumption starts at a low base and benefits from weaker commodity prices. Increasing aspirations of a young population, greater government transfers and easing interest rates can continue to drive local demand. Policy has helped provide macro stability. Reforms, though slower than market expectations, can begin to deliver results with time.
India is, therefore, well positioned to deliver strong, de-coupled growth, which should make its equity markets attractive over the medium-term.
The author is India equity strategist, Bank of America Merrill Lynch
