Large broking houses have now openly started questioning the speed of reforms. Jim Rogers was among the first to say that the Modi government has done nothing but talk in the year since it came to power. Marc Faber, editor of investment newsletter The Gloom Boom & Doom Report, says that the BSE Sensex can drop to 24,000 levels. Faber said that he is happy with Prime Minister Narendra Modi's willingness to reform the Indian economy, but “unhappy with the results”.
“Well, the S&P BSE Sensex went till the 30,000 mark and we can now easily drop to 24,000 - 25,000 levels. A lot will depend on monetary policy.” he told Business Standard in a recent interview.
Meanwhile foreign broking firm Citi has come out with a report titled ‘Is the faith in India turning fickle?’ Indian markets have in the current year underperformed the emerging markets by 7% on account of outflows and nervous chatter, the report notes.
According to Citi, there are five fundamentals/issues for the ‘faith tests’ ahead.
The first is the growth challenge. Uptick in GDP is soft, earnings have been cut by 8% since September 2014 and investment in the economy is sluggish. Broking firm Ambit in a report released Wednesday claimed that some big firms are deliberately creating a slowdown to hit back at the Modi government.
Citi, however, points out that on looking deeper, GDP growth is rational and there are returns-focused spends. Earnings ex-commodity companies are growing at 18% with an uptick in margins as well as cash flows. Growth currently is moderately placed but there is scope for higher return and lower risk growth ahead.
The second test Citi points out is that of high valuations. Indian equity markets, despite a recent fall, are trading at a historical average of 15 to 16 times its forward price earnings ratio. The fall in the market has been met with cut in profit estimates. But going forward, if interest rate cuts are passed on to the economy, over-leveraged corporates and stronger free cash flow companies can see valuation upsides, at least till earnings come back. Citi feels that there is a strong possibility of an interest rate cut of around 50 basis points and has thus increased market P-E multiple to 17 times. Citi expects Sensex to touch the 35,000 mark by June 2016.
The third test that India faces is of lower inflation. India’s high 10-year average inflation of around 8% has historically boosted nominal measures: top lines, earnings, ROEs (Return on Equity) as well as loan growth. But the current 3-4% inflation boost won’t be there in FY16 and beyond feels Citi. While trends in real numbers (adjusted for inflation) should be stronger than nominal ones; transition to lower nominal benchmarks could be a market challenge.
The fourth test will be of foreign flows. India has over the past two decades been a foreigner’s market with their holding touching nearly 23% in the top 500 companies. But this high ownership is also a risk. Thankfully domestic flows have increased and have cushioned the impact of withdrawal of money by FIIs. If domestic flow accelerates, they would be more than a hedge and have a meaningful impact by broadening the holdings.
The final test that Citi feels the Indian market will face is on government expectations. This is a question that is on the mind of many investors. Patience is clearly waning which is visible in analyst reports and expert commentaries. Citi says that there has been some push backs and some hold ups (GST, Land Bill and MAT). However, Citi rates the government performance fairly favourably as a lot has been delivered, some very aggressively as in the case of coal auctions. Citi feels that government should continue to add value to the economy and the market.
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