THE RBI decision to cut repo rate by 25 bps caught the Street by surprise on Wednesday, with the benchmark indices shooting to a record high in early trade. However, they ended the day in red as concerns of slower economic growth and tepid earnings led to profit-taking.
A general selling pressure experienced by the Asian peers — benchmarks from Indonesia, Thailand and Hong Kong lost 0.5% to 1% — also weighed.
The benchmark Sensex ended at 29,830.73, down 213 points or 0.72%, after rallying as much as 1.5% to a new all-time high of 30,024.74. The broader Nifty lost 73.6 points, or 0.8%, and closed at 8,922.65 after touching a third consecutive record high of 9,119.20.
While experts acknowledged the rate cut — this is the second surprise reduction by RBI in the last seven weeks — to be a near-term positive, they also expect the market to consolidate around the current levels with a possibility of some liquidation in case of a global risk-aversion.
“Even if lower interest rates are likely to provide financial gearing to corporate earnings, banks are yet to pass on these rate cuts. The market may consolidate for some time and a recovery in economic activity has to come through, for the strong momentum to continue,”said Andrew Holland, CEO, Ambit Investment Advisors.
While the October-December quarter earnings came in below expectations, the commentary from corporate India had a cautious tone, too, leading to several earning downgrades. Bloomberg data show that the consensus Sensex EPS (earnings per share ) estimates for fiscal 2015-16 came down from R1,905 to R1,800 in the last two months.
Not surprisingly, the current market valuations — the Sensex is trading at about 16.5 times its one-year forward earnings — appear stretched. While the current valuations are at a four-year high, the macro-economic and corporate earnings appear quite divergent compared to January 2011 when the Sensex last commanded a similar price-to-earnings multiple.
According to Gautam Chochoria, head of India Research at UBS, the valuations are not cheap and the GDP growth and earnings performance of India Inc may negatively surprise the Street in the next six months.
The general sentiment on the Street has remained upbeat in the last one week as most analysts praised the recently announced FY16 Union Budget. While the government postponed its road map for fiscal consolidation by a year, the pro-cyclical spending has largely been appreciated and seen giving a much needed thrust to economic activity. As the benchmarks rallied more than 2%, the valuations have also expanded to a new four-year high.
In a recent recent research report, Kotak Institutional Equities said it finds valuations of the Indian market full even after factoring in strong earnings growth over FY16-17.
The market rally of the last five sessions is largely driven by private sector banks with lenders like Axis Bank, Yes Bank, ICICI Bank and IndusInd Bank rallying anywhere between 7% and 11%. As a result, while the CNX Bank Nifty is trading at a trailing 12-month price to book ratio of 2 times, private banks are trading at 10% to 50% premium to their valuations four years back.
According to Rakesh Arora, head of research at Macquarie Capital, even as the valuations of private sector banks appeared stretched, they may continue to consolidate near their current prices. He says that while it may be too early for the rating downgrades to again pick pace, so far this quarter, companies are indicating slower sales. There are two near-term catalysts that could decided the consolidation range for the market.
“The Street will closely track how the government manages to get key legislation passed, which after Tuesday’s Rajya Sabha session, appears to be difficult. Even primary reports on monsoon expectations that will come around early April will gain importance,” said Arora.