Sensex: Where to From Here?

Tue, 11 Apr Pre-Open

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In the last couple of months, the BSE Sensex has been on a gaining spree and is within sniffing distance of a landmark 30,000. Not very long ago, during the bull market of 2014, Sensex targets of 30,000 and 40,000 were bandied about by market experts.

Indian stock markets have outperformed major global stock indices this year, gaining over 10%.The rally in the Indian equity market, from the February 2016 low, has been led by strong foreign portfolio investor inflows. Foreign institutional investors have invested more than Rs 300 billion in domestic equities. Also, domestic fund flows have been strong and kept the market going, often offsetting slowdown in foreign flows.

The foreign inflows are likely to sustain as the US Fed tempered expectations of front-loading interest rate hikes this year and the correction in the dollar index lured foreign investors towards emerging markets

Also, in the last two years, mutual funds have cornered over 4.5% of the total stock market capitalization up from about 3% two years ago, driven by steady inflow of monies through systematic investment plans. With mutual fund and insurance inflows continuing to grow at a robust pace, local money should also support the market going forward.

But, the pronounced bullishness in the stock market could subside in the coming weeks if the fourth quarter results of companies fail to live up to expectations.

According to an article in The Livemint, quarterly earnings are expected to be driven by bank stocks and metals companies. Banks' profit growth in the March quarter is likely to be boosted mostly as a result of a favorable base effect. Banks reported weak earnings in the year-ago period because of higher provisions following the Reserve Bank of India's asset quality review. For metals companies, higher commodity prices are expected to support earnings growth.

However, companies in the construction, cement and real estate spaces could report lackluster numbers. The sluggish demand environment aggravated by the acute shortage of cash, has hurt businesses such as automobiles. Two wheeler makers, in particular, are expected to put up a very modest performance with the ban on BS III vehicles. Even before the ban, demand for commercial vehicles was weak as reflected in the volume data.

Intensive competition in the telecom space following the continuation of the free data and voice offering from RJio in the March quarter, is expected to dent the profits of telecom companies.

The sensex is currently trading at 17.3 times estimated FY17 earnings. Considering the other MSCI indices, India's benchmark index is today one of the most expensive globally. The trailing twelve month P/E multiple of the Sensex is way higher than the long term average of 18 times.

Having said that, unlike in 2008, the earnings of Indian companies are far from their peak. And a steady revival in earnings could well keep the index at lofty valuations. Individual companies, especially mid and smallcaps may not have that luxury. And unless their earnings growth catch up to the steep market expectations in the coming quarters, a sharp correction could be inevitable.

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