Election euphoria to guide Dalal Street ahead of soft Q2 earnings

• India’s equity valuations will remain elevated as markets price in government continuity.
• There can be a slowdown from cyclical highs, but investors are expected to remain optimistic.
• Domestic inflows are expected to remain steady even as FII and FPI inflows have been slowing down.
• The Sept quarter might be soft but demand is expected to hold up due to festive season and Cricket World Cup, say analysts.
  

India Inc might see a softer earnings season ahead in the second quarter, with vagaries like uneven monsoon, rising inflation and rallying crude. The stock markets, however, are chugging ahead on long-term triggers like 2024 general elections.

Nomura has recently upgraded India to overweight on account of its structural story. It’s seen as a major beneficiary of the “China+1” theme, possessing a large, liquid equity market.

“Valuations are expensive but will likely remain so in a scenario of policy and government continuity. A cyclical slowdown from a high base is expected, but will unlikely deter investor optimism, in our view,” said Nomura.

Morgan Stanley also believes that the most important catalyst in the second half of 2023 is the market’s view on the 2024 general election outcome. The markets will also watch out for the outcomes of the polls in five states slated to take place this quarter.

“Even though we do not believe these state election results will have a lasting effect on share prices since state and general election outcomes may follow independent paths. The thing to watch for is how the opposition parties form alliances. In our base case, we expect the market to trade higher in the run-up to the 2024 polls,” said Morgan Stanley.

Foreign vs domestic funds

Globally, equity and bond markets are being driven by multiple uncertainties like Fed refusing to commit a pivot in rate hike cycle and lingering fears of recession. That has and will continue to affect FII and FPI inflows into the country.

FPIs have started packing off from the Indian equity markets, with their outflows crossing ₹10,000 crore in September. “With the ongoing correction in the US stock market, it is difficult for Indian shares to find a bid from abroad. This is particularly true for mid and small-cap stocks, which look rich relative to large caps,” said Morgan Stanley

India’s inclusion into the JP Morgan EM Bond Index is good news for inflows in 2024. Various estimates have suggested that it could bring in inflows anywhere between $30 and $50 billion. But few of that could affect the net flows in the upcoming quarter.

While there is little foreign money for emerging markets (EM), India’s performance has been better relative to its EM peers. In January to March, Indian stock markets saw double-digit growth, which moderated to around 7% growth on a relative basis in April-June.

“Though relative valuations remain rich, India’s low beta status implies outperformance versus EM if global equity market conditions get worse in October-December quarter,” said Morgan Stanley. While volatility in FPIs are given, domestic markets will keep seeing good inflows, the research firm believes.

The only hurdle to domestic flows being heightened primary market activity that could eat into secondary market inflows. A large number of mainboard as well as SME IPOs are slated to open in the coming weeks, with a robust pipeline ahead.

Oil on a boil & a soft Q2 earnings season

India as a country, as well as a large chunk of its companies are vulnerable to the rally that’s being seen in crude oil. A weaker Rupee as well as rise in oil prices has already widened August’s trade deficit to a ten-month high of $24.2 billion in August.

Also, many Indian sectors that had enjoyed a good run in profitability growth in Q1 in spite of slowing sales – might see their fortunes overturn.

According to economists at Bank of Baroda, cumulative India Inc’s profits grew 38.2% while sales grew at a modest 2.8% in Q1. This was on account of fall in expenses, due to softening raw material costs. This effect might go away in Q2 as crude rallied 30% since late June.

“While the quarter ending September is likely to be softer QoQ for earnings, the coming quarter could produce an upside surprise in terms of growth thanks to both the festival season and special events like the Cricket World Cup,” said Morgan Stanley.

Its FY24 earnings per share (EPS) estimates are about 10% above consensus, with a likely recovery in capital spending acting as a key source for upside to estimates. Nomura too sees oil price hit on Indian companies as an opportunity.

“We see recent softness driven by higher oil prices as an opportunity to raise exposure. While this weakness may persist in the near term, thus presenting even better timing, we think the window of opportunity might not be open for too long,” Nomura says.

The only risks to the euphoria on Indian markets is a potential surprise after May 2024 elections, China re-rotation and sustained high oil prices.

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