Rising risk appetite among domestic investors drove India’s benchmark stock indices to all-time highs for the second consecutive week, pushing stretched valuations even wider and raising concerns about irrational exuberance.
Record flows of household savings into mutual funds totalling more than $14.8 billion this year have spurred hectic buying despite worries the $2.3 trillion economy, stricken by demonetisation and messy launch of a new national sales tax, may take time to get back into full steam.
Adding to the warning signals, factory activity was sluggish in October as higher prices caused by the launch of Goods and Services Tax (GST) depressed demand. The Nikkei Manufacturing Purchasing Managers’ Index, compiled by IHS Markit, fell to 50.3 from September’s 51.2, marking its third month above the 50-point threshold that separates growth from contraction.
“India’s manufacturing companies struggled somewhat as the recent recovery enjoyed by the sector lost impetus in October. Disappointingly, manufacturing production rose at the weakest pace in the current sequence of growth,” said Aashna Dodhia, an economist at IHS Markit.
“Inflows of new orders stagnated as the negative effects arising from the implementation of GST continued to dampen demand levels.”
Strangely, the market shrugged off the data and the top-30 Sensex soared to a record 33,733.71 and closed at 33,685.56, taking gains so far this year to 26.5 per cent. The broader 50-share Nifty leapt to 10,453 before ending at 10,452.50, boosting the rise in 2017 to 27.7 per cent.
“We see an unattractive risk-reward for Nifty at these levels fundamentally,” Gautam Chhaochharia, head of India research at UBS Securities, wrote in a report and added, “flows can support rich valuations near-term though.”
Caution needed
Although quarterly corporate profits have mostly met market expectations, the runaway rise in stock prices far exceed the earnings growth. In many instances, the increase in profits was achieved through tighter control of costs rather than greater revenue. This would stand in good stead when sales pick up, but the problem is it may take time for demand to gather pace.
In other words, there is a case for brokerages to downgrade earnings, making the record-breaking stocks rally appear more lopsided.
From the results released up to around end-October, 26 per cent of Nifty companies missed consensus earnings expectations, while 41 per cent were in-line, according to Chhaochharia.
He said a consensus Nifty earnings growth estimate of 13 per cent year-on-year for 2017-18 implied 20 per cent growth in the second half, which appeared too high. UBS expects earnings to expand 7 per cent in 2017-18, and 13 per cent in 2018-19, well below consensus forecasts of 21 per cent.
“The July-September quarter trends so far don’t change our long-held view of the growth recovery disappointing investors, leading to earnings cuts,” Chhaochharia said.
Mihir Vora, director and chief investment officer at Max Life Insurance, is also circumspect about the near-term outlook for stocks.
“My current market view would be a bit cautious tactically,” he told ET Now television channel. “We are looking at an acceleration in GDP over 2018-19 but as far as 2017-18 is concerned, we are not seeing the kind of traction in earnings momentum or the GDP growth rate that is needed to justify these current valuations.”
“Because valuations are expensive there are fewer pockets of stock picking that we can see within the overall market,” he said, noting that the rise in prices of shares were way ahead of growth in fundamentals.
Cash flows
A greater share of household savings is flowing into mutual funds after New Delhi scrapped high-value currency notes a year ago taking the wind out of the sails of real estate and gold, two traditional investment avenues for decades. Falling interest rates have further added to the lure of equity and debt markets for better returns.
Total assets under management in the mutual fund industry have jumped by Rs. 1.42 trillion in the September quarter, or rising by seven per cent over April-June. Domestic funds have dethroned overseas portfolio investors as the primary driver of shares, with their purchases so far this year more than double that of foreign funds.
“We remain convinced that this trend is likely to continue as more and more households reallocate their savings from physical to financial assets,” Nilesh Shah, managing director at Kotak Asset Management Company, said in a column in the Economic Times.
A flood of initial public offerings is sucking cash away from the secondary market, but this is yet to show on share prices. In a majority of the IPOs, the cash raised is not going back into the business but is providing an exit route to venture capitalists or the government exchequer through divestments. Just how this would play out in the months ahead is not clear.
A Rs. 96 billion IPO by New India Assurance Co Ltd, an almost century-old general insurer owned by the government, was subscribed about 1.2 times, according to provisional data, when the offering closed on Friday. It was the second biggest IPO this year, behind General Insurance Corp of India’s Rs. 113.72 billion share sale in October.
Looking ahead
Brokerages are looking beyond 2017 when investor attention will shift to the next budget, due in early February. Analysts at Deutsche Bank believe New Delhi is likely to focus on agriculture, welfare and infrastructure — three sectors that will have a direct impact on voting patterns in the national election less than two years away.
“Budget expectations will start to emerge as the key influencers for Indian equity markets and determine both sector and stock selection,” the investment bank said in its India Strategy Report.
It expects “a sharp jump in spending on agriculture and rural development in 2018” because of the importance of the rural constituency in any election. The government’s recent decision to pump in Rs. 2.11 trillion to bolster the equity capital of state-controlled banks should also give a “renewed focus on lending to small and medium enterprises,” the report said.
Including another Rs. 7 trillion earmarked by the government for highways projects over the next five years, Deutsche Bank released a list of its top stock picks. These are: Reliance Industries, Larsen & Toubro, Mahindra & Mahindra, Tata Motors, Hindustan Unilever, ICICI Bank, Jubilant FoodWorks, Titan, Apollo Tyres, Bank of Baroda, Petronet LNG, Aurobindo Pharma, Shriram Transport, Dalmia Cement, Shree Cement, Coromandel, NTPC, Gujarat State Petronet and UPL.
The investment bank also added some stocks to its preferred portfolio, including Yes Bank, Dabur, JSW Steel, BHEL and Dalmia Bharat, while removing Power Grid Corp, Federal Bank, Mahindra Finance and Ramco Cement.
The writer is a journalist based in India
