Careful sector, stock selection warranted in Indian market: M Raychaudhuri

'We have a Sensex target of 66,000 by the end of CY23'

The Indian equity markets have been rangebound in the past 18 months due to a host of local and domestic factors. MANISHI RAYCHAUDHURI, Asia-Pacific equity strategist, BNP Paribas, in conversation with Puneet Wadhwa, says that in the near term, some of the Asian emerging-market (EM) peers, particularly those in North Asia, could outperform. India’s sustained outperformance should commence later this year once the earnings estimate downgrades are over. Edited excerpts:

Do you think 2023-24 (FY24) could prove to be a perfect storm for Indian equity markets as they deal with sticky inflation, the possibility of El Niño, and fears of global recession?

We believe FY24 will be a year of ‘middling’ returns for the Indian market. We have an S&P BSE Sensex target of 66,000 by the end of calendar year 2023 (CY23).

India’s macroeconomic outlook appears stable, with strong growth in non-food credit and goods and services tax collection, deleveraged corporate balance sheets, and robust government capital expenditure.

Inflation, measured by the Consumer Price Index, has been on a steady downtrend over the past year and, we believe, shall remain within the Reserve Bank of India’s 2-6 per cent range — enabling the central bank to hold interest rates in the June policy meeting and beyond.

The recent indication of a ‘US Federal Reserve peak’ should also help. The risks to Indian equities arise from downward pressure on earnings estimates and still-expensive relative valuations, even after the recent valuation correction.

Will India underperform its Asian and EM peers?

In the near term, some of the Asian EM peers, particularly those in North Asia, could outperform India. China and South Korea, for example, are trading at sharp valuation discounts to Asia and these markets’ long-term averages. No doubt there are concerns in these markets: China’s post-reopening growth could disappoint the market’s optimistic expectations and South Korean technology hardware exports could suffer from demand compression in the developed economies.

But investor options in these markets — especially in China — are vast, and coupled with cheap valuations, make these markets relatively attractive.

India’s sustained outperformance should commence later this year once the earnings estimate downgrades are over.
 

How significant is the outcome of state elections, especially in Karnataka, for market stability?

Based on our conversations with foreign investors, we are not overly concerned about the outcomes of provincial elections. Over the past eight/nine years, we have seen state election results have little correlation with the general election outcome. Our base case factors in political and policy stability in the foreseeable time horizon.Is it time to start buying stocks?

Careful sector and stock selection are warranted in the Indian market. In the Indian allocation of our Asian model portfolio, we are overweight on private banking, select insurance, consumer durables, health care, and information technology services.

We are underweight on materials, consumer staples, and industrial. Our focus is on companies with strong return on equity, robust cash generation, and likely stability in the earnings estimates.

Do you think we could see more buybacks and higher dividend payouts by India Inc as equity markets fail to deliver higher returns to shareholders in FY24?

It’s difficult to argue for a significant increase in dividend payout in India. 

India has always been a relatively capital-scarce market and the companies, to respond to the growing demand, need to fund organic expansion with the cash they generate. 

Several Asian high-dividend yield screens that we have created for our clients tend to throw up predominantly North Asian companies — very few from India figure there.

Foreign institutional investors (FIIs), not too long ago, according to you, were willing to pay a premium for Indian equities. However, their flows in the past few months tell a different story. What’s worrying them?

FII flows into India are shaped by India’s attractiveness to these investors and its outlook on other Asian markets.

From December through February, for instance, FIIs sold Indian stocks as they were focusing on China after its rapid unlocking.

 However, flows into India picked up again in March–May, as concerns about China’s growth sustainability occupied centre stage and recession concerns in developed economies dampened the outlook for North Asian exporters somewhat.

In our conversations with investors, the oft-voiced concerns are about premium valuations, the earnings picture in some sectors, and the strength of domestic consumption demand.

Any view on the 2022-23 January-March quarter results season?

The March quarter results have been disappointing for India and Asia. 

Currently, the aggregate reported earnings for companies in Morgan Stanley Capital International (MSCI) Asia (excluding Japan) have been 15-16 per cent lower than consensus estimates, and for those in MSCI India have been 18.6 per cent lower.

The consensus earnings growth estimate in CY23 for MSCI India is 21.3 per cent and that for calendar year 2024 is 18 per cent. 

However, we think there could be a downside to these estimates — especially in consumer discretionary, energy, materials, and industrial.