Brokerages turn cautious on markets amid slowing growth, rich valuation

The slump in key economic indicators and a sharp liquidity-driven rally since the government cut corporation tax on September 20, 2019 has made brokerages cautious on markets, who now indicate a limited upside for the indices in the short-to-medium term.

Since the cut in corporation tax, foreign portfolio investors (FPIs) have pumped in Rs 39,930 crore ($5.6 billion) till November 14 in equites, while mutual funds have invested a nearly Rs 6,000 crore, data show. The S&P BSE Sensex and Nifty 50 have gained 12 per cent and 11 per cent, respectively since then.

“Belying our expectations of a recovery starting in the third quarter (Q3), high-frequency indicators have plunged and domestic credit conditions remain tight amid weak global demand. As a result, we now expect India’s economic recovery to be delayed and the subsequent pickup to be sub-par,” wrote Sonal Varma, chief economist for India and Asia ex-Japan at Nomura in a recent report.

Analysts at CLSA, too, expect growth in real gross domestic product (GDP) for financial year 2019-2020 (FY20) could slip to 5 per cent. Their worst-case scenario stands 50 basis point (bps) lower than this projection at 4.5 per cent.

“India is in the middle of a severe credit contraction that started with the liquidity squeeze triggered by the crisis in the non-bank finance companies (NBFCs), which has now spread to deposit-taking companies as well. Modi’s corporate tax cuts are bold but will take time to gain traction. India’s recovery will be postponed to late 2020,” said Eric Fishwick, chief economist at CLSA.

Analysts at Kotak Institutional Equities led by Sanjeev Prasad, their managing director and co-head for institutional equities caution against the rich valuation Indian markets are trading at despite weak economic conditions.

"The Indian market is trading at rich valuations in the context of historical valuations despite a sluggish economy. The Nifty-50 trades at 22.4x FY2020E EPS and 17.7x FY2021E EPS. We remain skeptical of a quick recovery in the Indian economy given several structural issues, limited fiscal capacity to support consumption or investment demand and inefficacy of policy rate cuts given ‘crowding out’ by high government borrowings," he wrote in a recent co-authored report.

Those at Jefferies, too, believe it is too early to call a bottom for the macro, necessitating more policy support. The market, they say, craves a personal income tax cut, but the government has appeared hesitant given the fiscal constraints.

“Even without an expenditure stimulus, we expect the fiscal deficit to slip by around Rs 1 trillion or around 50 basis points (bps). We remain cautious. Overweights in our model portfolio include financials, industrials and technology and underweight consumer, materials and energy,” wrote Somshankar Sinha, managing director and head of equity research for India at Jefferies in a recent co-authored report with analysts Piyush Nahar and Pratik Chaudhuri.

BNP Paribas Securities sees the S&P BSE Sensex at 40,500 by end-2019 – just 0.5 per cent higher from the current levels. Nomura, on the other hand, maintains a March 2020 Nifty50 target of 12,545 – 5.5 per cent higher from the current levels. As an investment strategy, they prefer corporate banks, insurance, infrastructure and healthcare sectors. They are underweight consumer, autos, IT services and non-bank finance companies (NBFCs). 

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