Expert view: Market multiples may see a de-rating over next 12 months, says Nitin Bhasin of Ambit

Nitin Bhasin, the head of institutional equities at Ambit, says negative earnings surprises have increased over the last two quarters, which may continue, leading to a potential de-rating of market multiples over the next 12 months. He believes the current financial year (FY25) may be a year of earnings normalisation, and small and mid-caps, trading at near all-time high valuations, will likely benefit from a bottom-up approach. In an interview with Mint, Bhasin shares his thoughts about the current market valuation and what the market expects from the upcoming Union Budget 2024.

Edited excerpts:

We have a coalition government at the Centre. Do you expect the pace of growth, which was earlier anticipated, to slow down? Can there be a major policy shift from capital expenditure to revenue expenditure?

The power dynamics under a coalition government undoubtedly change, but it would be unreasonable to believe that genuine economic reforms will take a back seat. 

In fact, coalition governments in India have been credited with implementing bold reforms. 

Measures that might centralise power, like One Nation, One Election, could take a back seat, but economic reforms will likely proceed as planned. 

The government must address the economic demand issues, especially at the middle and bottom of the pyramid. 

However, this does not necessarily mean that the government will have to reduce capital expenditure to accommodate higher revenue expenditure. 

Such adjustments can be made within the existing framework utilising additional revenues, such as RBI dividends, without upsetting fiscal calculations.

What are the market's expectations from Budget 2024? What are the key areas that the government should focus on?

The markets generally anticipate measures from the government to alleviate distress at the bottom of the pyramid through increased expenditure. 

We expect such measures in the upcoming budget, possibly including higher allocations for schemes like PM-KISAN and MGNREGA. 

The government could also consider reducing income tax rates for low and middle-income earners to boost demand. 

However, we do not foresee an increase in the fiscal deficit or a reduction in capital expenditure to fund additional revenue expenditure. 

These measures should align with the existing fiscal deficit target of 5.1 per cent of GDP for FY25, down from 5.6 per cent in FY24.

It is now evident that the Fed will only cut rates once this year, and any rate cuts are likely to be modest. Do you think the era of ultra-low interest rates from before the pandemic is over? How should retail investors invest in a higher interest rate environment?

The growth-inflation dynamics in the US suggest that more than one rate cut in CY24 is unlikely. 

Overcoming the last phase of disinflation has proven to be challenging. Therefore, investors should prepare for 'higher-for-longer' interest rates. 

Investing in quality names, preferably large caps, would be a prudent strategy.

What are your thoughts on the current valuation of the Indian market? Is it sustainable?

All equity segments—large-caps, mid-caps, and small-caps—are trading at the higher end of their TTM (trailing 12-month) P/B (price-to-book) ranges, indicating subdued returns in the coming year. 

While large caps appear relatively less expensive, there is a significant divergence in valuations between BFSI and non-BFSI sectors. 

Currently, the Nifty Ex-BFSI universe trades at an all-time high premium of 44 per cent over BFSI on a 12-month forward P/E (price-to-earnings) basis, compared to a five-year average of nearly 6 per cent. 

We expect this gap to normalize this year. 

With earnings growth slowing down, valuations for mid and small-caps should also stabilise. 

We do not anticipate market multiples sustaining, as FY25 is expected to normalize earnings trajectory estimates. 

Negative earnings surprises have increased over the last two quarters, with aggregate NSE 500 earnings surprises at -3 per cent. 

This trend is likely to continue, leading to a potential de-rating of market multiples over the next 12 months.

Which sectors are expected to see healthy gains in the next one to two years?

Banks: The banking sector is robust, with high capital levels, significant coverage of NPAs, stable asset quality, and consistent loan growth of 15-16 per cent year-on-year (YoY). 

Despite contributing around 50 per cent of Nifty FY24 EPS growth, banks have underperformed the market by approximately 8 per cent over the past 12 months. 

We expect this underperformance to reverse, with banks outperforming the Nifty by about 20 per cent over the next 12 months.

Telecom: Despite recent re-rating, the telecom industry remains promising due to favourable regulatory conditions and enterprise and home entertainment services opportunities. 

The consensus earnings trajectory for telecom firms also points to positive growth in FY25 and FY26.

India is expected to experience an above-normal monsoon this year. How will this impact market sentiment?

An above-normal monsoon is positive news for India. Agricultural growth declined to 1.4 per cent in FY24, down from 4.7 per cent in FY23, adversely affecting rural consumption. 

A normal monsoon should boost agricultural GVA growth, aided by a low base effect, which will, in turn, stimulate demand. 

Increased spending on welfare schemes, widely expected in this scenario, will further alleviate stress in rural areas. 

FMCG and auto companies with high rural exposure are likely to benefit the most from improved sentiment.

Would you recommend investing in the IT sector at this juncture? What is the outlook for them?

We maintain a fundamental ‘sell’ call in the IT sector. Growth, margins, and cash generation have deteriorated across the sector.

FY24 saw the highest consensus EPS (earning per share) estimate cuts for Nifty IT since 2009, despite only a mild correction in the Nifty IT index in CY24.

Market expectations for strong earnings growth reversion in FY25 seem optimistic, and we anticipate further earnings downgrades.

Despite valuation concerns, mid and small-caps have shown resilience. What should be the investment strategy for these segments?

As mentioned earlier, FY25 is expected to be a year of earnings normalisation.

Small and mid-caps, trading at near all-time high valuations, will likely benefit from a bottom-up approach.

An earnings momentum strategy focused on stocks with sequential TTM EPS expansion (TTM EPS quarter-on-quarter per cent) can potentially generate alpha in the current environment.

This strategy has historically outperformed the index, particularly in small and mid-cap segments.

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Disclaimer: The views and recommendations above are those of the expert, not Mint. We advise investors to consult certified experts before making any investment decisions.