Brokerages cautious on market outlook

Public sector lenders to be hit the most, with their higher exposure to this segment

While the Street has welcomed last week's election results with a 500 point up-move on the Sensex, brokerages are guarded on further gains.

This is due to an adverse interest rate cycle, higher bond yields in developed markets, impacting the flow of liquidity in general, and expensive valuations. Bank of America Merrill Lynch (BofaML) analysts say the domestic equity market, trading at above-average multiples, is susceptible to global risks. And, earnings are expected to see the effects of demonetisation in the March quarter. The brokerage is cautious on the near term.

Gautam Duggad and Nikhil Gupta of Motilal Oswal Securities are cautiously optimistic, preferring stocks with earnings visibility. The brokerage believes focus would soon revert to fundamentals, as valuations at 18 times the FY18 earnings estimate do not provide meaningful room for a rise.

The poll wins for the ruling party are expected to strengthen the government's resolve on addressing key pending issues such as non-performing loans at banks. However, analysts at Kotak Institutional Equities Research believe earnings will be key to the market's performance, as global and domestic interest rate cycles are likely to turn less supportive. Earnings recovery has not been as expected; earnings per share for the Sensex has remained flattish since FY13.

Analysts expect earnings to grow in FY18 but there are no triggers for an earnings upgrade at this juncture. So, Varun Lohchab and Rahul Agrawal of Religare Institutional Research advise investors to sell into this rally, as the risk-reward ratio is not favourable. Positive earnings surprises, they say, are the only trigger.

Apart from earnings, news flow around two events, the monsoon and goods and services tax implementation, will also have a strong bearing on market sentiment.

The sectors to benefit the most are banks, cement and consumption-led rural plays. BofaML analysts believe a continued war on cash should be good for banks, resulting in more inclusion, fees and higher lending. More government spending on irrigation and affordable housing could boost cement demand. Loan waivers and discounts should be good for consumer and two-wheeler stocks. But, how it plays and who bears the bill for loan waivers will be crucial, and is the biggest uncertainty as of now.

Which is why most analysts are more positive on private banks than public sector ones. Antique Stock Broking analysts believe that if investments pick up in Uttar Pradesh (UP), so will demand. The state is eight to 15 per cent of the total market for products ranging from cement to building materials to tractors to automobiles.

Other UP-specific developments could reflect positively on some stocks. Analysts at Anand Rathi say irrigation projects and Ganga water purification plans would benefit companies such as Praj Industries, Thermax, VA Tech Wabag, ITD Cementation and Kirloskar Brothers, beside engineering, procurement and construction entities.

Also, given the agricultural focus and demand from UP, skewed towards more di-ammonium phosphate and less of nitrogen, phosphorus and potassium (NPK) fertiliser usage, north-based entities in this segment such as Chambal, RCF and Zuari Agro will benefit more than the south-based NPK ones such as Coromandel International, believe analysts at Motilal Oswal Securities.