Indian Market May See A Period Of Consolidation, Says Kotak Institutional Equities

The Indian market may see a period of consolidation after the recent run-up in stock prices, according to Kotak Institutional Equities.

Rich valuations across sectors will likely cap upside, while a reasonable macro-economic position, improving profitability, volumes in the consumption sectors, and a powerful medium-term narrative about India will likely protect downside, the research firm said.

Both inflation and the current account deficit or balance of payments look manageable, Kotak said. Although, these factors can turn quickly, given India’s vulnerability to domestic food and global fuel shocks, it said.

In fact, both have seen sharp price increases in the past few weeks. Consumption demand continues to be sluggish, while investment demand is steady, Kotak said.

The current valuations of the Indian market largely price in most short-term and medium-term positives, but do not factor in any short-term risks or medium-term challenges of lower profitability and likely lower multiples across major consumption sectors and stocks, according to Kotak.

"In other words, there is no margin of safety in current valuations, and any major negative event could lead to a large and swift correction in stock prices, given inflated multiples," it said in its Aug. 15 note.

The rich valuations of almost all consumption, investment, and outsourcing stocks suggest high optimism among investors about an eventual recovery in volumes, further recovery in profitability in the short term, and sustained high profitability and financial returns of companies in the medium term.

The Nifty 50 is up 6% in the past three months. However, the mid-cap and small-cap stocks have done even better, which would highlight the general optimism around India and the Indian market, Kotak said.

The market may find support from stable global interest rates over the next two-three quarters, given the sharp decline in headline inflation in the U.S. and the expectation of similar declines in other developed market economies, and the potential decline in global bond yields from current elevated levels after the next two to four quarters, as and when central banks signal a change in stance of their current tight monetary policy stance and/or the market discounts the same.

The first quarter results showed continued demand weakness for automobiles and consumer staples, with no visible recovery in rural demand and information and technology services, with revenues lagging.

Investment demand continues to be strong, with capital goods companies showing robust growth in both order inflows and revenues and cement companies reporting double-digit volume growth.

Profitability has increased both quarter-on-quarter and year-on-year across sectors, led by stable-to-higher product prices and stable-to-lower raw material prices.

Kotak expects modest growth in Nifty 50 companies' earnings in the coming year after their first-quarter net profit and Ebitda rose 30% year-on-year (3.4% above Kotak's expectation of 26% year-on-year growth, and 13.8% year-on-year (2.2% above Kotak's expectation of 11.4% year-on-year growth), respectively.

"We expect net profits of the Nifty 50 index to grow 16% in FY2024 and 13% in FY2025," Kotak said.