 "<b>Devangshu Datta:</b> Don't uncork the bubbly just yet")
Investors have waited six quarters for signs of the proverbial green shoots that indicate a turnaround in the business cycle. The Q1 results suggest that the long wait may finally be coming to an end. The results of 2,500-odd companies (ex-banks) indicate that sales rose 9.5 per cent year-on-year (YoY) while operating profits rose by 11 per cent and net profits went up by 16 per cent. The good news was spread across several sectors which is a good augury for growth revival.
Before indulging in premature celebrations, adjust expectations for the following points. First, India Inc. is moving to the new Ind AS accounting standards, which means many restatements of previous results. The differences are large in the case of consolidated results of corporates with many subsidiaries and joint ventures.
Second, banks delivered the expected dose of horror as the clean-up of non-performing assets (NPAs) continued. Totalled up, net profit for a bunch of 40 banks has fallen by 60 per cent YoY, as the provisioning for NPAs rises. What is even worse, total banking revenues grew by just five per cent. This indicates credit offtake is still languishing at multi-year lows. Low credit growth is not associated with high corporate growth. This indicates that the recovery could be an unsustainable flash in the pan.
Third, valuations are at historically uncomfortable levels. The major indices like the Nifty and the Sensex are trading at trailing PEs of 23X. This is above the range of the 10-year average Nifty PE (19.4) plus one standard deviation (3.04). The short-to-medium term returns from investments at these levels tends to be negative and the three-year compound annual growth rate for investments made at PE of 22.5 and above is two per cent.
Nor can such valuations be justified by the PEG (PE: earnings growth ratio), which theorises that fair value is at a PEG of one or lower. The Nifty is trading at close to 1.5 PEG, if we optimistically assume that NP growth will be maintained at 16 per cent. Nor can PE 23 be justified in terms of comparison to Treasury yields of 7.10 per cent - the recent T-yields would only justify PE of about 14.
The answer to the valuation comment is that "this time it's different" because most of the big money is coming from overseas. It's true that foreign portfolio investors (FPIs) have been the major buyers of both rupee equity and debt in this fiscal as domestic institutions have been sellers since June. As everybody knows, FPIs raise their corpus in regimes with negative rates or very low interest rates and FPIs are seeking high returns anywhere they are available. Hence, they might find PE 23 quite acceptable and so long as they stay bullish, the market will do fine.
The banking situation may have got critical enough for the government to start taking desperate measures. The State Bank of India (SBI), for example, has been allowed to merge its subsidiaries and associates. Let's see how this goes but SBI is better off than several other large public sector banks. There is no obvious way in which the government can avoid massive sums spent in recapitalisation (maybe Rs 2 trillion will be needed for Basel III adoption) and it must also put systems in place to prevent such profligacy happening again.
Banking crisis impede overall growth and the record across other sectors is still spotty despite the improvements. Automobiles have done well, so has cement and these are positive surprises. Tea, coffee and sugar are three cash crops that are in bull runs. Power transmission, infrastructure development, textiles and capital goods have all delivered improved performances. But there have been disappointments, too, in key segments like fast-moving consumer goods, pharma and in IT, where both top line and bottom line growth have been unimpressive.
Given the corporate results, and the last Index of Industrial Production data (IIP is 2.1 YoY for June 2016) and inflation numbers (6.07 per cent YoY in July), one can certainly hope that the GDP growth projections will be met. But inflation is above the Reserve Bank of India's (RBI) target zone and the IIP doesn't suggest a major pick-up in activity yet.
The RBI will soon have to start its swap-reversal programme to the tune of anything up to $34 billion over the next three months. That might cause some major ripples in forex markets. The auction of telecom spectrum in late September will be another straw in the wind when it comes to gauging sentiment. At the base prices, Rs 5.6 trillion worth of spectrum will be bid out. That is roughly thrice the telecom industry turnover for 2015-16. Telecom operators will have to borrow heavily to bid for that spectrum and it remains to be seen how enthusiastic the response is.
The external picture remains foggy with slow growth likely across the globe. The Fed might wait until after the presidential election in November before it raises the USD policy rate but the chances are it will hike in December. Elsewhere, the yen strengthens and tensions rise on the Ukraine-Russia border.
Technically, the market continues to look quite bullish. The Nifty Bank made a breakout, pushing past strong resistance at 19,100 last week. The Nifty itself is testing resistance at the 8,700 zone. If it also has a breakout, there may be a move till the 9,000 level.