Things do not seem to add up: We continue to like the top-down India story but not the increasing gap between valuations and fundamentals. For the market to rise further, either some of the laggards with somewhat suspect fundamentals will have to perform or expensive favoured stocks become even richer. Even on global and domestic macroeconomic issues, we see growing signs of disconnect between markets’ benign expectations and the underlying realities.
Indian market valuations: Top-down and bottom-up numbers and views don’t reconcile. For the market to go up 10% by end-FY2017, it would need to trade at around 17X FY2018E EPS. That is possible but the market has rarely traded at those levels for long. On a bottom-up basis, either (1) every stock would have to be 10% higher, which means some of the favoured stocks would have to trade at even higher multiples or (2) some of the laggards would have to rise significantly. The market continues to cling on to the ‘rich’ stocks and has turned its affection to the laggards now. We are not sure if that’s a good or bad sign.
Banks and NBFCs: Lending is easy, young man, recovering harder. We use the Indian BFSI sector as an example since the sector has seen an astonishing change in perception in the past few weeks. We note that the market had been quite prompt to award the rapid growth in assets of banks over the past few years, only to regret it later. We do not doubt the credit processes of NBFCs but simply highlight that the stocks have rallied sharply on hopes of rapid growth in their assets and NII and improvement in financial ratios on likely economic recovery. As for the other issue of credit quality of banks, we will let investors decide on it.
Global markets: How long before Pavlov’s dog figures it out that there is no food coming? We wonder how long markets will continue to have faith in the ‘magical’ powers of the global central banks to revive global economic growth. They have reacted positively to central banks’ interventions in the manner of Pavlov’s dog over the past few years. However, the effect is wearing thin now with the market perhaps realising that central bank interventions alone will not solve global growth issues and there is a ‘lower’ bound to cost of equity. Governments have largely abdicated the responsibility of management of economies through other means (fiscal and structural reforms) to the central banks. The bells are ringing (loud and clear) but there is no food coming!
Inflation: The benign inflation view of the market does not stack up with cost-push inflation. We would be a bit wary of benign inflation assumptions, especially as cost pressures will start to emerge over the next few months. (1) The 4-9% increase in MSPs of kharif crops, (2) sharp increase in retail auto fuel prices, which will result in high y-o-y changes from August 2016 and (3) rebound in global metal prices and higher import tariffs on domestic steel will show in general inflation. Our current trajectory shows inflation rising to above 5% by end-FY2017 with core inflation staying above 5% through FY2017. The inflation trajectory does not factor in the impact of 7CPC payouts-related impact.
—Kotak Institutional Equities