In the short term, inflation might go up, but in the medium term it would be non-inflationary through reduction in aggregate demand
Our bullish stance on the Sensex, when we released our strategy on May 24 this year, with a target of 18,700, has been achieved. The rally was led by improvements in sentiment, basically on the fiscal side, given the diesel price increase. As we expected, the benefits of the rupee appreciation followed suit. This is good news for the markets.
This is a first step to fiscal consolidation, which reduces the odds of additional borrowings. In the short term, inflation could go up, but in the medium term, it would be non-inflationary in nature, through reduction in aggregate demand. Most important, the intent of the government to try to achieve fiscal consolidation by the withdrawal of subsidies and austerity measures would reflect in the country not being downgraded. This, in our view, is a very big positive. Sovereign downgrades are more dangerous than structural slowdown. We expect the fiscal consolidation to come in at 5.5 per cent against the targeted 5.1 per cent. Last year, it was 5.9 per cent.
The plethora of reform measures announced by the government has added to the sentiments. But in our view, both foreign direct investment in retailing and airlines will take a long time to bear results. It aids sentiments but does not change the structural damage to the markets in terms of overall slowdown in the economy and subsequently the earnings of the market.
As regards flows to the emerging markets, the zero-rate regime of the US Fed is expected to continue till CY2015 and the US 10-year treasury has already broken the 1.5 per cent. In the past, this had led flows to emerging markets and India had always benefitted given the smaller market-cap of its stocks.
Going forward, we continue to hold our bullish view on the Indian markets as we did six months ago but our projections were based on price-to-earnings, DDM (dividend discount model) of the Sensex, price/book value and regression of the earnings yield. With the convergence of the Sensex with 18,700, the yield gap has closed and we expect the Sensex over the next month to correct to 17,300 levels. Expecting greater or equal flows in the balance part of the calendar/fiscal year and expecting the early bird investors not to take profits would be slightly over optimistic.
Going into the current quarter results season (at long last, a quarter with growth), we expect the earnings of our Karvy universe to exhibit a profit growth of 14 per cent year-on-year (y-o-y). On a quarter-on-quarter basis earnings are expected to decline by five per cent. While revenues are expected to grow by 15 per cent y-o-y, earnings before interest, taxes, depreciation and amortisation growth is likely to be lower at nine per cent y-o-y due to compression in margins.
Having said that, we believe that sectors like banking and auto would correct and would also underperform the next rally as well. We find metals, logistics, cement and midcaps (extremely selective plays) as sunrise sectors, which would outperform the Sensex as it resumes the upward journey post a three- to five-week correction. Despite a healthy performance we believe defensive sectors like pharmaceuticals and consumer staples/durables to outperform the market given their earnings growth is far ahead of the Sensex earnings growth.
The author is head (institutional equities), Karvy Stock Broking Ltd
