Large-caps might see a correction to digest gains: Tirthankar Patnaik

He adds one overhang on markets would be equity supply in form of IPOs, QIPs, among others

Tirthankar Patnaik, the India Strategist at Mizuho Bank, says one overhang on the markets would be the supply of equity in the form of initial public offers (IPOs), qualified institutional placements (QIPs), and other capital raises lined up for the year. Edited excerpts of a talk with Puneet Wadhwa:

Are the markets ripe for a correction?

With key triggers behind us and a broad-based earnings recovery still elusive, we would not be surprised if large-caps undergo a time-correction to digest recent gains. The run-up in the mid-cap and small-cap space has been even sharper and we do see pockets of irrational exuberance, which might eventually culminate in a price-correction in these segments.

What are the key risks and triggers for the markets?

For the markets, a favourable monsoon is largely priced in, as is the global rate rationalisation, with some room for a positive surprise from the Reserve Bank of India (RBI) in August. The triggers would be a positive surprise in earnings that would stall the current downgrade cycle in analyst estimates. The central bank also seems to have been comfortable with the inflationary impact of the impending Goods and Services Tax (GST). However, another overhang on the markets would be the supply of equity available this year, given the range of initial public offers (IPOs), qualified institutional placements (QIPs) and other capital raises seen this year.

How do valuations look at this stage?

Valuation-wise, we are well beyond the 10-year average of around 14.5 times for the Nifty 50, at around 18. While we remain constructive on the markets, given the growth trajectory of the underlying macro environment, continued performance at this level would either require sustained capital inflow from domestic and foreign investors or a revival in earnings after the March quarter. Both are unlikely to continue without a break, albeit a short one.

How disruptive will GST be for the economy and India Inc?

Implementation of GST would be inimical to customer-facing business to consumer sectors like automobiles, fast moving consumer goods and, to some extent, cement and the retail space. Apart from these sectors, the effect of GST would be driven by the differential between existing and proposed tax slabs, either on input costs or on finished products. We believe preparation for GST differs widely across sectors and across size, with the smaller players, particularly the small and medium enterprises space, likely to take much longer in adjusting to the invoice-level tracking required.

Your view on farm loan waivers and its likely impact on banks?

Farm loan waivers are not a good idea. The only silver lining here is that in most cases, the load to tackle the burden will lie with state governments, not the central government. The funding will be through state government bonds or state development loans. While the overall loan amount will not impact the fiscal deficit much, it will start showing up in bond yields. More paper will have a negative impact on yields at a time when RBI, in our view, is likely to cut interest rates.

For banks, it will be a moral hazard, as anyone with agricultural loans will start to worry. We have seen this earlier, when the United Progressive Alliance government announced farm loan waivers. We have documented cases where farmers who had the capability to repay had also applied for a waiver. Though banks will get their dues, there will be near-term stress.

How convincing was the recent macroeconomic data? When do you expect a rate cut?

Gross domestic product and index of industrial production (IIP) data, along with the later data on CPI (consumer price index) inflation, point to a weakly improving macro environment, which had a mini-correction in the first quarter of FY17 that intensified after demonetisation in November.

Inflation dynamics seem to have a taken a definite turn due south, driven by the sharp drop in food inflation, which was highlighted in the (Reserve Bank's) Credit Policy and corroborated further with inflation data for May. The most striking aspect of the policy document is its sharp downward revision of the perceived inflation trajectory in FY18. While the policy avoids an abrupt change in stance (back to being dovish and accommodative, from the current hawkish and neutral), only in the guise of a wait-and-watch attitude until the current scenario plays out, we maintain expectations of further easing in FY18, led by a 25 basis point cut in August.

Have you made changes to corporate earnings estimates for FY18, given the coming GST implementation?

March quarter earnings were above expectations overall but led by a handful of (cyclical) stocks, with Nifty profit after tax growth at 15 per cent, an 11-quarter high but not enough to raise our estimates, given the low FY17 earnings growth of around 1.5 per cent. We maintain estimates of 20 per cent in FY18 and 16 per cent in FY19.