At the beginning of the year, our view of the Indian market was balanced with a neutral rating, factoring in a potential short-term underperformance due to premium valuations and a hawkish monetary policy stance. Subsequently, the broad market underwent a correction of about -10% (December 2022 to March 2023) due to selling by FIIs and retail investors. Post March 2023, it turned positive and has gained momentum from June onwards, led by strong inflows from both sections, a reversal of valuation to the long-term average, and a rebound in earnings growth. We upgrade our outlook for FY24 while maintaining a neutral rating due to the global economic slowdown.
A strong revival in domestic economic activities in Q4FY23 and a forecast of high growth to sustain in Q1FY24 are uplifting the momentum. Currently, the domestic corporate earnings growth forecast for FY24 is built at +18%, led by an expansion in margin. The US economy has been able to avoid the recession, though the next two quarters of September and December are forecast to be tough. This may not have an impact on the Indian economy as the China Plus 1 strategy is subsiding the effect to date; the Chinese economy’s data has been continuously slowing down. El Nino may not upset in Q2 and Q3, as the risk has moderated due to improved monsoon conditions and above average long-term reservoir levels.
We feel that the market has become more optimistic than euphoric. However, the upside of the main indices may be limited in the short-term. Nevertheless, we continue to have a constructive view on the stock market, with an optimistic view on small caps in the short-term. We see favourable prospects in sectors such as Pharma, IT (long-term contra bet), Private Banks and Manufacturing.
Indian market is in a better position to catch-up
Year-to-date, the performance of the Indian market has exceeded expectations, witnessing a remarkable surge following the significant sell-off between December 2022 and March 2023. During the consolidation period, the domestic market corrected by about 10%, driven by concerns of a global recession and high valuations potentially leading to a local slowdown and selloff. A sell-off did happen, but on the contrary, the global and domestic economies have demonstrated resilience. Since April, there has been a strong shift from selling to buying in the local market, propelling it to new highs and registering a remarkable 16% increase from the March low to 19th July. Year-to-date, the Nifty50 has surged by 9%. And we may have to catch up more with other markets, like the US.
The S&P500 and Nasdaq are up by 19% and 45% YTD, respectively. The valuation of the S&P500 has experienced a notable increase to 20x one year forward, up from 15x nine months ago. This is above the long-term average of 17.5x. The factors that supported this rally are that the economy was managed better to avoid a deep recession, Fed and government support for the US medium-sized bank crisis, and developments in artificial intelligence (AI) bringing new business opportunities. However, sustaining the current historic levels may prove to be a challenge in the face of a fading economy and a slowdown in financial liquidity. Funds are moving to Emerging Markets, and in this context, comparatively, the Indian market is in a better position to perform, being the fastest growing economy and trading at 19x. In the short term, the main indices may experience limited upside potential, but the downside risks are well mitigated due to the strong rebound in corporate earnings growth. Small caps appear more appealing from a short-term perspective.
It’s a bumper start to FY24 earnings
Nifty50 Q1 consolidated profit after tax (PAT) is forecast to grow by more than 20% YoY. This positive outlook marks a significant shift from the subdued presumptions prevailing in the market a couple of quarters ago. The economy has undergone a substantial transformation beyond initial forecasts, with India’s Gross domestic product (GDP) growth and corporate performance being bolstered by steady domestic demand and consistent external orders. India’s Q4FY23 actual GDP growth increased to 6.1% compared to the consensus of 5% YoY.
And this sanguine outlook is expected to continue in Q1FY24. Key high-frequency data from April to June has been robust, like purchasing managers index (PMI), goods and services tax (GST) collection, credit growth, and auto sales. Corporate earnings are forecast to be strong, and a large part of the revamp is due to an expansion in the operating margin as key raw material prices have heavily corrected YoY. Currently, key international commodity prices, from crude to steel, are down by a range of 20 to 40% from last year’s peak, drastically reducing the cost of manufacturing.
Regarding demand, it is stable due to external orders led by China plus strategy and steady local demand led by government and private expenditure. And the expansion in margins is expected to persist in the near future, as the recent decrease in raw material prices will continue to benefit corporates with a lag. However, it is important to note that the extent of improvements may be constrained in the latter part of the year due to the base effect, a potential global economic slowdown, and the already high forecast of +18% corporate earnings growth in FY24.
Sectoral wins and misses
We need to note that though Q1 earnings growth is forecast to be robust, revenue growth is muted at 7.3%. This is due to a decline in commodity prices, which led to a reduction in realization. Hence, demand has to revert positively, or else the possibility of further upside in corporate financials will be limited. The consensus among economists is that the growth forecast in the US and Eurozone will become more pessimistic in the July and December 2023 quarters.
The majority of Q1 earnings growth is through commodity linked sectors like oil marketing companies (OMCs) due to the fall in crude prices and high refining margins, which may not sustain in the future. Banking and NBFCs are forecasted to achieve robust earnings growth, led by 15% credit growth and lower provision. Despite an accelerated deposit growth rate of 12.1%, the declining current and savings account ratio (CASA) will limit margin improvement in the near future. The auto sector is projected to see healthy revenue growth due to strong operational performance, aided by margin expansion and reasonable volume growth across segments.
Conversely, sectors such as IT, cement, metals, and chemicals are expected to face challenges in the near term. IT revenue growth is expected to be muted due to macroeconomic challenges and delayed discretionary spending. However, diligent cost management, improved utilization rates, and a sharp moderation in US inflation are expected to contribute to stable operating performance, making it an attractive long-term contra bet.
Cement sector growth will moderate due to weak demand and a decline in prices; however, the benefit of lower input costs and volume growth will be realized from the next quarter onwards. The metals and chemicals sectors are likely to be impacted by declining raw material prices, high channel inventory, sluggish orders, and a delayed monsoon season. Similarly, the pharma sector displays a slightly weaker outlook, primarily due to the economic recession in developed nations and increased costs of chemicals. However, Pharma is a good long-term bet due to its attractive valuation.
Regarding expectations for mid and small cap stocks, a similar trend of muted top-line and decent net income growth is expected. And we can expect better performance from mid and small cap corporates in the coming quarters due to a lag in economic efficiency. The monsoon deficit has narrowed, and rural activities are rapidly expanding, a benefit that will be visible in Q2-Q3. On valuation terms, small caps are attractive compared to large and mid-caps trading below the long-term averages.
Update in market target
We forecast our Nifty50 target for December 2024 at 21,000, which is again valued at a one year forward P/E of 17x. The peak case is valued at a P/E of 20x, assigning a target of 24,750, while the trough is at a low base of 14x, arriving at a target of 17,300 (please refer to the Geojit market strategy report: http://geoj.it/iPln0E, dated 13 July 2023, for more details).
