Positive signs

Bulls can stretch valuations

The bullish market reaction after the Assembly election results can be attributed to a “policy continuity” premium. Most political commentators are assuming the Bharatiya Janata Party will do well in the 2024 Lok Sabha elections and, thus, the policy focus will remain the same. However, it is not only the political factor that is driving sentiment. Market action in November, before the Assembly election results were announced, was strongly positive. Every industry index registered gains in November, with real estate leading the pack. Sectors such as automobile and health care registered month-on-month gains of over 10 per cent. The Nifty50 was up 5.5 per cent in November while the smallcap and midcap gains were in double digits. Investors are also betting that a strong rebound in gross domestic product growth rates, coupled with relatively benign inflation projections, will translate into big gains in corporate revenue allied to improved profit margins. Prices of crude oil and gas spiked with the Hamas attack in early October but normalised through November.

Further, the power demand has spiked. Even adjusting for seasonal vagaries, this suggests higher economic activity. There are signs of consumption demand revival in the hinterland, and corporate investment is picking up. Heavy engineering firms like Larsen & Toubro and capital goods manufacturers, such as BHEL, ABB, and Siemens, have order books running at above two times the current annual turnovers. That ensures visibility of revenues through the next two financial years at least. It’s heartening that a significant portion of new orders is coming from the private sector as well as overseas. New areas like data centres, electric vehicles, and green energy are contributing to order books.

Households do a large proportion of annual buying in the festival season and that must be taken into account when looking at the October-November data. Auto-sector unit volumes expanded through the festival season. The auto industry has a long supply chain, starting with primary metals, and moving through electronics to service industries like advertising and financing. A volume recovery indicates consumption revival, which should be transmitted through the supply chain. The mortgage and real estate data indicates, however, that demand for housing is still K-shaped with high-end properties seeing more takers than the affordable segment.

Bank credit has expanded strongly through this financial year (until November) alongside that of non-banking financial companies (NBFCs). This is despite elevated interest rates. Indeed, the Reserve Bank of India (RBI) has been concerned enough to increase risk weighting for unsecured loans to prevent possible overheating in retail loan segments. Another encouraging sign is that the banking and finance space is in good shape. While deposit growth has been healthy, credit has grown quite strongly. The cost of funds for banks and NBFCs is likely to rise as the credit-deposit ratio tightens. Hence, net interest margins could be compressed. The RBI’s tight monetary stance is likely to continue but election-related spending should boost demand. The apprehensions are more about valuations than about missed earnings projections in 2023-24. The political factor and its impact on sentiment will loom larger as the elections draw nearer. Earnings projections being upgraded can be justified in the light of the corporate and macro data. However, the Nifty is trending at a current price-to-earnings (PE) ratio of 22, while the smallcaps are at a PE of 27-28. Valuations would be stretched if the bull run continues.