The domestic market has been witnessing a remarkable rally for the last few sessions but the road ahead may not be smooth as the country's growth prospects remain weak amid the risk of inflation and the prospects of earnings downgrades.
Brokerage firm Kotak Institutional Equities expects equity markets to stay muted in the near term despite the surprising pause by the RBI and market valuations becoming more reasonable after a large time-wise correction over the past two years.
"We note a few headwinds—(1) growth prospects remain weak, (2) inflation faces upside risks and (3) earnings downgrade risks exist, especially in consumer discretionary and outsourcing sectors. In our view, bottom-up valuations do not price potential risks adequately in the case of most sectors," said Kotak.
The brokerage firm highlighted that the weakness in domestic consumption demand and a slowdown in IT exports will hit India's growth prospects in the current financial year.
"Our channel checks suggest renewed weakness in consumption demand from the month of March after a brief revival in February. Consumption weakness is more prominent in discretionary categories, especially in muted auto sales. Commentaries from consumer companies suggest a slight recovery in staples but entrenched weakness in discretionary categories. We may have a better grasp on domestic recovery during the 4QFY23 results season," said Kotak.
"Furthermore, a slowdown in IT exports may further dampen India’s growth prospects in FY2024; hiring has become more cautious," Kotak said.
While there is a risk of economic slowdown, inflation remains a key concern due to volatile food and fuel prices.
Kotak said there are potential upside risks from food and fuel inflation adding to likely elevated core inflation, notwithstanding the surprising pause by the RBI on policy rates in its recent MPC meeting and its forecasts of benign inflation.
As per the RBI, India’s real gross domestic product (GDP) growth for 2023-24 may remain at 6.5 percent, with Q1 at 7.8 percent, Q2 at 6.2 percent, Q3 at 6.1 percent, and Q4 at 5.9 percent.
On the other hand, CPI (retail) inflation is projected to moderate to 5.2 percent for 2023-24, as per the RBI, with Q1 at 5.1 percent, Q2 at 5.4 percent, Q3 at 5.4 percent, and Q4 at 5.2 percent.
Kotak highlighted that food inflation faces supply-side challenges from possible weak rabi crop output, due to unseasonal rains, ongoing milk shortages and climate-linked risks to Kharif output, while oil prices may remain high due to tight oil markets, especially after the recent cut in OPEC production.
Kotak sees a possibility of earnings downgrades in many sectors.
"We note earnings cut in increasingly more sectors under coverage. The intensity of earnings downgrades is more prominent in consumer discretionary as well as pharmaceuticals and speciality chemicals. The growing breadth of downgrades poses risks to our earnings growth of 15 percent for FY24E and 16 percent for FY25E for the Nifty50 Index," said Kotak.
On the front of valuations, Kotak said the Indian market valuations may appear more reasonable compared to recent history, but earnings downside risks exist given the increasing uncertainty around growth.
As per the brokerage firm, Nifty50 trades at 19.4 times FY2024E EPS and 16.7 times FY25E EPS.
"Most consumption, outsourcing and investment stocks appear rich, given the increased risk of further cuts to earnings, while banks and NBFCs continue to remain attractive," said Kotak.
Disclaimer: The views and recommendations given in this article are those of the broking firm. These do not represent the views of MintGenie.