Valuation mismatch: Earnings remain grounded, markets continue to soar

Strategists have pointed out that high-frequency data continue to remain weak suggesting the process of economic recovery could be a prolonged one.

Despite a string of downgrades post the disappointing Q2FY20 results and chances of earnings growth not living up to estimates, India’s markets continue to trade at exalted valuations. The Nifty now trades at 22.4 times FY20 estimated earnings, on a free-float basis while it trades at 17.7 times estimated earnings for FY21.

By current reckoning, net profits for the Nifty 50 are expected to grow by 11% FY20, down from 18% prior to the earnings season, according to Kotak Institutional Equities. As analysts at Jefferies noted, earnings estimates have come off by 3% in the last month alone even though the corporation tax rate has fallen, a fact that has prompted the brokerage to stay cautious on the markets at a time when valuations are elevated.

Strategists have pointed out that high-frequency data continue to remain weak suggesting the process of economic recovery could be a prolonged one.

The risks to earnings growth, they say, are tilted to the downside. Among the most worrying data relates to the contraction in railway freight by 11% year-on-year in October for the fourth straight month; wholesale volumes for commercial vehicles fell 23% y-o-y, with M&HV sales falling 50% y-o-y.

While India’s IIP contracted 4.3% y-o-y in September, with power generation falling 3.4% in September analysts believe the trend could worsen in October, going by production trends in core sectors.