QE Tapering May Spur Volatility

Pankaj Pandey
Head Research
ICICIdirect.com

CAPEX BOOSTERS

We expect a further reduction in rates from the RBI by 50-75 bps throughout FY14. Coupled with the reforms process, this will provide the impetus for a gradual pick-up in the capex cycle.

FAIR VALUATIONS

Indian markets are trading at reasonable multiple of 13.5x the FY14 earnings, and the equity markets’ performance is expected to align with the corporate earnings growth going forward.

The Indian markets have been fairly resilient given the challenging environment, though the benchmark Nifty has been in a range of 5500-6200. During the beginning of the year, insufficient reforms and inflation were the primary concerns, but these have now been replaced by currency woes (about to touch Rs 60 vs USD), CAD (at record high levels) and GDP (at a record low).

Among the positives, FIIs have been big buyers of Indian equities, though there is now some retreat given the QE tapering phenomenon that has set in. We believe that this is just a temporary shifting of liquidity in the global landscape and is pretty common to the emerging markets. On one hand, risky assets and fixed income instruments have seen outflows (to the tune of ~USD 3.3 billion and USD 400 million from the debt and equity markets respectively in the month of June 2013 till date) while on the other, emerging market currencies have depreciated around 5-15 per cent against the USD.

Going into H2CY13, we believe that global liquidity allocation would focus back on the core fundamentals of respective economies and asset classes across the globe. In that respect, we expect India to stand out as the more prominent issues of inflation (recent reading of 4.7 per cent), gold prices correcting from the USD 1500 levels to USD 1300 currently and a possible decline in commodity prices due to the slowing of major importers like China would aid in the taming of CAD and currency volatility. In addition, ongoing reform measures such as increasing the FDI limit in various capital intensive sectors as well as addressing issues on core infra sectors such as power, oil & gas and telecom would provide some much needed relief to the investment climate.

Putting the above factors in the Indian context, we believe that there are signs that the macros are turning in India’s factor, and by H2CY13 the trends will be more prominent. The Sensex EPS has grown at 6.8 per cent in FY12 and 6.2 per cent in FY13 to 1165 and 1236 respectively. In Q4FY13, the earnings of Sensex companies were in line with the subdued expectations. The aggregate revenues of these companies (excluding BFSI) rose ~7.2 per cent YoY, led by relatively safer sectors such as pharma and IT which reported ~22 per cent and ~16 per cent YoY topline growth respectively. The operating profits remained flat, while the bottomlines dropped by 9.3 per cent.

However, we believe that the macroeconomic scenario would improve from here on, albeit at a slower pace. We expect a further reduction in rates from the RBI by 50-75 bps throughout FY14. Coupled with the reforms process, this will provide the impetus for a gradual pick-up in the capex cycle. Accordingly, we expect the Sensex EPS to grow by 11.7 per cent to 1381 in FY14E.

From the valuations perspective, Indian markets are trading at reasonable multiple of 13.5x the FY14 earnings, and the equity markets’ performance is expected to align with the corporate earnings growth going forward. Within sectors, the defensives have done much better in terms of price performance compared to their earnings growth, while capital intensive sectors have been beaten down much more than the decline in their earnings. We expect that consumer stocks, pharma, IT and private banking will continue to post reasonable earnings growth whereas sectors such as infra, power, metals, PSU banking and capital goods will face the pressure of muted macros and higher interest costs. From a risk-reward perspective, we prefer the pharma, IT, telecom, media and auto sectors, as the divergence between valuations and growth is not steep.

In the near-term, the equity markets along with other asset classes are likely to be volatile as the tapering of QE would create anxiety. However, such volatility coupled with significant declines in the markets will offer an opportunity to investors to accumulate good businesses in a staggered manner.