Indian equities have rallied nearly 9% YTD. This is largely in line with other global index YTD returns. In India, while we expect the longer-term business cycle to improve in the next two-three years, we see near-term returns capped from here on due to possible near-term reversal of a global wave, market’s under-appreciation of residual impact of demonetisation, rich valuations and continued risks of earnings downgrades for commodity impact on margins.
While momentum for equity markets is strong, our December 2017 Sensex target for 29,000 leaves little upside room. While markets have looked through the impact of demonetisation, earnings have not especially been in the discretionary sectors. When companies speak of ‘normalisation’, they mostly refer to a restoration of volumes.
Equities are, however, pricing in a restoration of growth. This difference is important, and still needs to be tested. We had argued in December that the market was getting too pessimistic. With expectations and prices now at highs, the risk seems now on the other side. We stay underweight in the discretionary space.
You might also want to see this:
The recent sharp rally has taken the market again into expensive territory. Sensex 12m fwd PE of 17X is 13% above long-term averages. At these multiples markets have historically struggled to deliver positive return over the subsequent 12 months.