Market may be rallying, but bulls are walking on thin ice: Here’s why

Market may be rallying, but bulls are walking on thin ice: Here’s why

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Image result for Market may be rallying, but bulls are walking on thin ice: Here’s whySome analysts say this week’s rally is being driven by short coverings, but others say all is well with fundamentals, and the market is pricing in future growth.
 NEW DELHI: As the Nifty50 climbed the 9,800 level from 9,500 in just eight sessions, it left everyone wondering what might have brought the bulls back on Dalal Street with all guns blazing.

Some analysts say this week’s rally is being driven by short coverings, but others say all is well with fundamentals, and the market is pricing in future growth.

But past experiences show earnings have hardly come the way analysts predict. Will it be different this year?

BEER ratio raises red flag

With a trailing 12-month multiple of 23.29, Sensex’s earning yield stands at 4.29, 218 basis points lower than the 10-year bond yield of 6.478. The BEER (bond-equity earnings yield ratio) thus stands at 1.5. Since bond yields are seen as risk-free, a BEER value above 1 signals rich stock valuations, which means the market may be headed for a correction.

India Inc’s June quarter earnings are widely expected to be tepid as in the runup to the GST rollout, there was a massive slowdown in manufacturing.

Yet, the forward PE multiples for Indian equity indices stand at 17.9, next only to those in the US and ahead of their five-year historical average. This compared with 13.4 (forward) for China and roughly 11-17.6 for other Asian markets.

Déjà vu: A tale of two halves

Brokerage Motilal Oswal Securities noted that just like FY16 and FY17, where broadbased market earnings were impacted by asset quality review (H2FY16) and demonetisation (H2FY17), GST will result in a similar disruption in FY18.

“We expect trade inventory destocking and teething troubles related to GST implementation to hit H1FY18 earnings for B2C sectors. However, they should normalise in H2FY18. Additionally, a few sectors will benefit from a low base in H2FY17,” the brokerage said.

Pre-GST pain

JM Financial sees Nifty50 firms to report a negative growth of 5.4 per cent for June quarter. Kotak Securities, on the other hand, expects net income of Sensex firms to be flat on a YoY basis.

“We foresee 8 per cent YoY decline in net income for our coverage universe, including auto (inventory clearing due to GST), downstream energy (lower refining margins and adventitious losses due to recent correction in crude prices), pharma (disruption in domestic formulation businesses again due to GST) and telecom (continuation of hyper-competitive sector activity),” Kotak Securities said.

The consensus Sensex EPS estimates for FY18 and FY2019 now stand at Rs 1,470 and Rs 1,833, respectively. For Nifty, the same are estimated at Rs 478 and Rs 586.

Where is margin of safety

Vikas Khemani of Edelweiss Securities notes that the margin of safety has narrowed down significantly or “probably has gone down, in fact, maybe it has become negative in some cases.”

Dipan Mehta, Member, BSE & NSE, said it is increasingly becoming difficult to identify good stocks at reasonable valuations, where there is some margin of safety.

“June quarter and September quarter numbers may throw up a few disappointments, maybe temporarily, because of GST-related issues. You have a situation where stocks are richly valued and the next couple of earning seasons do not promise much excitement,” Mehta said.

That should act as a kind of roof on the top of the market, and no new investment theme or investment idea is coming up at least in largecaps or midcaps. One cannot clearly buy existing ones at these levels without compromising, Mehta said.

JM Financial said given the expensive multiples based on elevated growth expectations, there is little margin of safety at current level, even though the short-term momentum looks strong.

Khemani told ETNow that the only way to deal with the market, especially when you are in a structural market, Is to temper down expectations.

Among sectors he expects financials to do well. Within financials, Khemani likes select private sector banks and NBFCs like housing finance companies and some of the newer segments such as insurance.

He said because of GST, some of the consumption-driven sectors might see some disruption, leading to a correction in stock prices.

“There could be very good entry points because you know that the trend is in your favours. The long-term story or any correction should be used structurally as an opportunity to buy. I continue to be bullish on investment-driven sectors where huge amount of execution is under way. It will only accelerate from here on. These are the two-three sectors, that can deliver good returns over the next 12 to 18 months,,” Khemani said.

Motilal Oswal is betting on a few themes to play out. One of them is the rural stimulus theme.

The brokerage noted that a series of farm loan waivers, coupled with two consecutive years of normal monsoon and the highest MSP hikes in five years should act as a stimulus for rural consumption.

JM Financial noted that the largest contributors to earnings over FY18/19 will be financials, metals and consumer discretionary (autos) while telecom and IT should bring up the rear.

In terms of sector multiples, while earnings cut for the cement sector seems to have stabilised, trading multiples for largecap names are close to 2STD historical means. Among others, FMCG has seen a 2.6 per cent cut to EPS expectations while the multiples have expanded. The multiples for IT and pharma have moderated in line with cuts to EPS, he said.