Subdued earnings recovery heightens downgrade risks

The Indian stock market has been undergoing a correction since September 27 and significantly underperforming its Asian peers. India is at a risk of seeing its premium valuations, held since May 2021, narrowing in the coming months. In contrast, global investors are increasingly drawn to the Chinese market due to its low valuations and recent stimulus initiatives. FII outflows have exacerbated recently amid escalating geopolitical tensions. The surge in oil prices poses a challenge to the domestic economy if it sticks above $80-85 for a long time, currently below $80.

A positive surprise last week was the ruling party's stronger-than-expected performance in the Haryana and Jammu & Kashmir state elections, which defied exit poll predictions. This result brought a degree of optimism to the domestic market, despite ongoing caution in global markets. Accordingly, the broad market exhibited some resilience and attempted to bounce back with the Nifty50 index finding support at the 24,800 level. However, this support remains tentative, posing the risk of being an intermediate level. The market failed to end on a positive note last week with the Nifty50 settling below 25,000. The outcome of the ongoing corporate Q2 results is a key factor going forward.

The RBI policy outcome was neutral. While no rate cut was expected, the shift in the policy stance from 'withdrawal of accommodation' to 'neutral' offered some relief to the market. Holistically, an upward revision in Q3FY25 inflation reiterates that retail inflation continues to be sticky. The volatility in input prices and the impact on margin dragged FMCG stocks. The change in the RBI's stance is favourable, but the commentary is not pointing to a rate cut in the near term due to sticky inflation. However, by late 2024 or early 2025, a rate cut may be possible, especially if the US Fed implements substantial cuts. As such a move could widen the cross-country interest rate gap, potentially impacting the INR’s valuation.

Earnings Outlook

The Q2 earnings preview is weak, though marginally better compared to the subdued Q1. Nifty5o index PAT is expected to grow by 8-10% year-on-year (YoY) compared to 6-7% in Q1. But generally, the revamp is subdued across the economy, with extreme weakness in sectors like Oil & Gas, FMCG, Cement and Banks. Traction is noted in a few sections such as Telecom, Metals and Power. The main reasons for the low increase in profitability or quarter-on-quarter (QoQ) improvement are lack of enhancement in global demand, reduction in domestic demand like government & rural spending, and high inflation. Elevated global and rural inflation and reduction in realisations are affecting sales and margins. In the last 2-3 years, India has been benefiting due to the expansion of the operating margin, which today, is in a flattish to contraction mode.

The initial signs of Q2 results paint a discouraging picture for corporate earnings growth in the short term. Subsequently, weak Q1 and Q2 results will lead to the question whether the growth will get revamped in Q3 and Q4 as anticipated by the market. If the risk of a downgrade, as seen in Q1, continues to rise, it could erode India's premium valuation. Over the past 3-4 years, India has enjoyed a high premium, but this may diminish, leading to short-term market caution.

though the market is cautious, investor sentiment continues to be buoyed. Investors are looking at opportunities on a stock-to-stock basis to capitalise on recent correction and ongoing consolidation. At the same time, investors are also reassessing their portfolios as concern is arising that equity assets will have to bear the weakness due to a slowdown in the economy and tightening of liquidity. Promising sectors are consumption, FMCG, infrastructure, new-generation stocks, manufacturing, and chemicals. Conversely, sectors like capital goods, real estate, IT, pharmaceuticals, and autos may be at a greater risk of underperforming in the short to medium term.

(The author is Head of Research at Geojit Financial Services)

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