Coronavirus outbreak: Market valuations may fall further, say experts

The risk of default by highly leveraged companies has increased significantly
Last week’s steep fall in leading indices has made market valuations cheaper, as compared to the start of 2020. The Nifty, after about 10 per cent decline from its high, is trading at slightly more than 17x FY21 estimated earnings and is now closer to its mean one-year forward valuations of 16.5x. 

Experts, however, believe investors still need to tread with caution, given the downside risks to growth and earnings. 

The fall in the Indian market is being led by the decline in the global markets, given the rapidly spreading coronavirus and the expected slowdown in global growth and corporate earnings. The US market, which was trading firm, has seen a steep decline on the back of risks faced by the global economy. Experts point out the epidemic is now beyond the Chinese borders, and the countries in the European Union which have porous borders are witnessing a rapid spreading of the virus. 

The markets are now fearing that the epidemic could now turn into a pandemic, says Siddhartha Khemka, head-retail research, Motilal Oswal Financial Services. Investors are fearful that this might lead to a global recession as the outbreak is spreading in the world's largest economy, the US.

Global businesses themselves have become vulnerable. For one, companies will see supplies getting affected as orders in the pipeline are not being supplied by China. Many would have already paid for supplies, and hence would feel the pressure on working capital, too. 

 
Note: % change and EPS upgrade/downgrade are over January 2, 2020, as the global markets were closed on January 1; for the Sensex, it is over January 1, 2020 | Source: Bloomberg

The risk of default by highly leveraged companies has increased significantly, points out Pankaj Bobade, fundamental research head at Axis Securities. All these concerns are impacting investor sentiments.

Because of these events, Nischal Maheshwari at Centrum Broking sees an impact of 0.5-0.6 per cent to the world’s GDP and, therefore, he remains cautious.

However, given the sharp fall in the markets and the various measures being taken by central bankers (interest rate cuts) and governments around the world, some intermittent bounce back is not ruled out either.

For countries like India, declining commodity prices, especially of crude oil, bode well. India, so far, also has been able to restrict spreading of the virus in the country. Further, with falling inflation, the scope for further interest rate cuts by the Reserve Bank of India (RBI) in the coming policy meeting has increased. 

The RBI had left interest rates unchanged in its last policy because of inflation concerns. So, any further cuts will be positive for interest rate sensitives, while companies (paints, tyres and others) using crude oil as raw material are already set to see gains. Moreover, the correction in large caps has made them somewhat attractive. Broader indices like BSE MidCap and SmallCap have lost less and outperformed the Sensex/Nifty.

Deepak Jasani, head of retail research at HDFC Securities, sounds a note of caution. “While the overall valuation of the broader markets has become cheaper post the recent correction and may boost sentiments, earnings growth is more important. We are not sure earnings growth has bottomed out,” he says. The lower crude oil prices and other factors may be good for macros (fiscal deficit, etc), but may not be significantly beneficial for micros — which, in turn, drive earnings for companies.

 It may be noted that India’s leading indices are among the ones which have fallen the least since the start of 2020. Also, while most markets have seen a downgrade in their earnings estimate by 1-6 per cent, the figure for India has been flat. And, most brokerages expect a jump of over 20 per cent in earnings in FY21. Moreover, India’s price-to-earnings valuations are still the highest among global peers. Hence, there is also a possibility of a sharper decline in the indices, led by earnings downgrade and de-rating of the markets/valuations, if the situation worsens.

For now, the Indian indices would continue to track the overseas markets, which are likely to be under stress in the near term as the outbreak adversely impacts supply chains across the globe, including India, says Ajit Mishra, VP-research, Religare Broking. Misra believes any likely relief in terms of Q3 GDP bottoming out may also not have the desired positive impact on the markets, until the concerns over the virus ease. 



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