Frontline stocks & broader markets may crack further

Indian equities may be headed for another round of correction, as reality replaces optimism. Over the last 15 trading sessions, the Sensex is down 5.5%, but strategists believe further correction is likely. Over the last one week, India's underperformed other emerging market peers.

Indian markets have been the toast of global investors for over a year now, as the macro-economic fundamentals continued to improve compared to other Asian neighbours. Till February this year, the only risk to equities was the 'overweight' position of global funds, but with corporate India exiting FY15 on a weak note, the India story doesn't look as rosy.

The markets have till now ignored several high-frequency indicators on its upward journey. But with earnings showing no sign of recovering, India's 'overweight' position is at risk. The earnings so far has been a disappointment as many companies have not managed to deliver on the modest expectations of the Street. Kotak Institutional Equities sees potential correction in the high-growth quality stocks, if investors start questioning the Street's earnings assumptions. "Even with a 15-20% correction, valuations would remain heady," the brokerage says. The market trades at a multiple of 18 times its FY16 earnings. Even though earnings estimates have been cut over the last few weeks, consensus estimates for FY16 continue to hover around 17.5%, which still seems too high. The negative momentum in earnings will take much longer than six months to turn around.

It is apparent that the some of the exuberance around India may have irrational. Keeping in mind that earnings are expected to remain depressed for some more time, valuations now look rather expensive. In addition, India's core sector growth in March has been the slowest in a decade. CLSA has done a comprehensive analysis of high frequency indicators and has concluded that "recovery still eludes".

In the month of March, cement production declined 12% year-on-year while exports declined 21%. Two-wheeler sales too declined one% YoY. While credit and deposit growth picked up to 12.6% and 12.9% respectively, it was largely due to the year-end demand and due to a capex revival. Jefferies says economic activity moderated sharply in the March quarter and its Activity Index growth slipped to just one%, a 10-month low against 4.3% in 9MFY15.

After the exuberance, downgrades have already started for Indian equities. Credit Suisse has downgraded India to neutral from outperform versus the MSCI Asia ex-Japan after its outperformance over the past 12 months. Michael Strobaek, global CIO, and Giles Keating, head of research at Credit Suisse believe that India looks expensive as "Valuation of Indian equities has become stretched at a 12-month forward price/earnings of 18.1, representing an 18.5% premium to the 10-year average." The government's move to levy MAT on foreign investors has only aggravated things.