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Too Fast, Too Furious?

Updated: Jul 19, 2023


Indian markets rally sharply at new highs:



We had turned positive on the markets in our last quarter note in April, 2023 (see attached -

https://www.valentisadvisors.com ). Yet even we were surprised by the pace of the rally. The Nifty

rallied by 10.5% during the quarter with the broader markets faring even better – the Nifty Mid-

cap index was up 19% and the Nifty Small Cap Index was up 20.5%. All the indices hit an all-time

high during the quarter.



Where do we go from here? We continue to remain bullish on the markets in longer term as

reiterated in many of our previous notes. Firstly, India will be the best performing economy

globally over the next few years. Secondly, India will see strong earnings growth on the back of

rising GDP. Lastly, India will continue to attract long term foreign investors to the equity

markets as its rising GDP and earnings growth is accompanied by high quality bottoms up

companies with sustainable and consistent high RoCE and RoE ratios.



Yet, near term we think investors should stagger their investments and use dips to buy the

market. Valuations have become expensive again and could lead to price and time correction.

Secondly, inflation has been sticky and rising on the margin. With El Nino fears still existing, any

failure of the monsoon could drive inflation higher. Thirdly, while a Fed rate hike in July is

probably baked in the market already, we think the market still remains over optimistic of a Fed

cut this year.



#1: Earnings in India continue to be robust


Earnings in India continue to be robust and we expect an earnings growth of 12-14% for FY24.

While the street is expecting a higher growth, we think global commodity earnings may see

downgrades in case of a slow-down in the global economies.

The current earnings season for the June quarter will again be strong with Nifty companies likely

to grow earnings at 25% yoy. However, this may be exaggerating growth since the oil marketing

companies’ (OMC) profits are anticipated to surge to INR405b in 1QFY24 from a loss of INR185b in

1QFY23 owing to strong marketing margins. Ex-OMC, Nifty’s earnings should rise 11% YoY for the

quarter.



Overall earnings growth is likely to be driven once again by domestic cyclicals such as BFSI and

Auto, which are expected to post 47% and 11x YoY jump. Metals and Cement are anticipated to

drag the aggregates with a 53% and 17% YoY decline in earnings, respectively.







… In contrast USA is seeing a recession at least in earnings


Consensus expectations for US companies for the June quarter are bleak in contrast to India

with consensus estimates projecting a decline of about 7% yoy in earnings per share among

S&P 500 companies. Many of the leading Wall Street brokerages are echoing the bleak

message. S&P 500 companies are expected to see zero YoY revenue growth for the first time

in 10 quarters, as per Goldman Sachs. UBS expects earnings in this quarter to mark the

steepest decline since 2020.



#2: Global Funds continue to favor Indian markets


Global fund managers continue to be bullish on the Indian markets and this reiterates our long-

standing view that India will continue to see higher weights in most global equity indices. This was

reiterated in our recent trip to Hong Kong where we met some of the large FPI investors in India.

Most reiterated that India remains one of the most positive markets for them from a 3-5 year

view with high valuations being the only near term negative.



It is not just equity market investors but also debt investors globally who are getting increasingly

bullish on India. India has now overtaken China as the most attractive Emerging Market

for investing in Emerging Market debt according to a survey done by US Invesco. The institutions

they polled collectively manage approximately US$21 trillion in assets.



The reasons cited in the survey align with our themes for India. India was viewed increasingly

positively for its improved business and political stability, favorable demographics, regulatory

initiatives, and a friendly environment for sovereign investors. India is also benefitting from

increased foreign corporate investment aimed at both domestic and international demand

through “friend-shoring” and “near-shoring” (think of the China+1 theme that we have highlighted

earlier).



#3: Valuations back in expensive territory – stagger investments



We had turned positive on markets 3 months ago since valuations had turned reasonable. With

the sharp rally over past 3 months, valuations have again turned expensive with a 1-year forward

PE of the Nifty at 20.2x, well above long term averages. Similarly in a relative context too

valuations are getting expensive with India now trading a premium of 100% to the MSCI PE ratio

well above the long term average of 56%. We think this could lead to a time and price correction

in the markets and we would prefer to invest in a staggered manner.






#4: Inflation inching up in India while it is falling in USA


Our base case remains that RBI will be on pause for the rest of the year. However, inflation in

India which was less than US inflation for 16 months in a row has proved stickier than US inflation.

US inflation has fallen rapidly and now is well below Indian inflation.






Weak agriculture crop could put pressure on inflation


While rains have hit India with a vengeance, the monsoon deficit has evaporated. But more

critically, sowing data is lagging miserably and the heavy rainfall has affected sowing further.

Moreover, forecasters still expect El Nino to hurt monsoons in the later part of the season. Any

crop failure due to a weak monsoon could put pressure on inflation. The current sharp jump in

tomato prices highlights how quickly agriculture commodities can react to small changes in

production deficits.








#5: Fed hike discounted? Is the market too optimistic on a Fed cut?


The last Fed policy meeting surprised – they paused but sounded hawkish expecting 2 rate hikes in

the rest of 2023. We think the market has largely discounted a hike in the July policy. While the

market still expects Fed to cut rates this year, we thing there is scope for some disappointment. As

Bank of America points out, it is pretty rare for Fed to cut with inflation being this high and unemployment being this low.







#6: We still prefer small caps but buy dips



We still think over next few years small caps will out-perform large caps as they will grow earnings

faster in a rising economy. However, just given the near term rally, we would wait for better entry

points in any correction in the market. Small caps have rallied sharply over past year and the

relative valuation discount to large caps is now pretty low in a historical context.








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