Slowing rural consumption may keep the equity markets in check, says Rakesh Arora, MD & head of Research at Macquarie Capital. In an interview with Devangi Gandhi, Arora points out that 2012-13 earnings expectations are still to price in the effect of a slowdown in rural consumption.
Excerpts:
Do the fundamentals justify the rally in the market?
The current rally is the result of increased FII inflows and hopes of market fundamentals improving, both of which may not last too long. We do not feel the recent run-up is a bull market rally, it?s a rebound on the back of a decline in the inflation. Our 2012 target for the Sensex is 14,000 and we believe the Street will shift focus to slowdown in earnings once the euphoria of the liquidity-driven rally is over.
Headline inflation has eased and could fall to as low as 6% by April, but we expect it to move up to 7-7.5% post May 2012. While we see RBI cutting interest rates as early as March, these may not be more than 75 to 100 bps over a year.
There are expectations that rate cuts may cause a big rally. Do you agree?
Markets may not rally much because we don?t think that fundamentals are right for it. Moreover, the market has been de-rated. We are expecting further downgrades in earnings expectations. Currently, consensus earnings expectations for the Sensex for 2012-13 is close to R1,300, which we feel could see a 7-8% correction, mainly due to lower revenue growth. Analysts are building in demand expectations of 10% plus while we do not see a growth of more than 7%. In the last five years, along with a GDP growth of near 9%, demand growth has been 10-15% for various commodities. We are projecting a GDP growth of 6.9% for the next year and are also expecting inflation to remain in a range of 6-7%, much above last few year?s band. Analysts have already cut their Ebitda margins. However, they haven?t really cut the revenue numbers and this is where we think the disappointment will come from.
What would cause a slow-down in demand?
We are mainly worried about a slow-down in rural consumption that has been the central theme for the market in last two years. The fallout of a sharp decline in food inflation is that farmers are getting less for their production. Internationally, prices of commodities like rice and sugar, which are the export products, have come down drastically. Farmers are also facing sharp inflation in terms of cost increases because of Narega.
While urban demand may get a cushion from the interest rate cuts, rural demand may not. Hence, we are apprehensive about the demand outlook for 2012-13 which is not correctly reflected in optimistic estimates so far.
What is your outlook on interest rate sensitive sectors?
As people build in expectations of interest rate rate cuts, the churning towards interest-rate sensitives has already started. Stocks from the auto, real estate and banking space have seen rally in the recent past. However, this is unlikely to sustain because we see rate cuts as symbolic in nature given our base case of elevated inflation for the next year. We are highly underweight on financials as we see more NPAs and restructuring of loans. We don?t see any major sign of a capex revival even as there is a lot of talk and intention to ramp up spending by government. We don?t expect any major pick up in the activity in the next 2-3 quarters.
