Modi Promise Succumbs to Earnings Reality as Stocks Slide

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Narendra Modi
Narendra Modi, India's prime minister. Photographer: Tomohiro Ohsumi/Bloomberg

Indian stock investors’ year-long infatuation with Prime Minister Narendra Modi is coming to an end.

After surging about 40 percent in the 12 months through February, the benchmark S&P BSE Sensex index sank 4.8 percent in March for its biggest retreat in 25 months. Strategists are cutting forecasts for the equity gauge for the first time in six quarters, while estimates for fiscal 2016 earnings have dropped by 4.7 percent since the end of December.

With shares in Asia’s fourth-biggest stock market trading near the most expensive levels since 2010, investors are looking for more evidence that Modi’s efforts to propel growth will lead to a revival in corporate profitability. While the Bharatiya Janata Party leader has cut bureaucracy and boosted infrastructure spending since taking power in May, opposition politicians have hampered his ability to push through permanent measures designed to attract foreign capital and spur economic expansion.

“The market is in a precarious position,” said Rakesh Arora, the head of research at Macquarie Capital Securities India Pvt., whose Sensex forecasts were the most accurate in Bloomberg surveys over the past two years. “While India continues to remain an attractive market from a two-to-three-year perspective, there seems to be growing restlessness around the timing, or lack thereof, of policy execution and earnings delivery.”

Sensex Target

Mumbai-based Arora trimmed his year-end Sensex target by 4 percent from three months ago to 31,600 as he pared his profit growth projection. That compares with an average estimate of 32,640 in a Bloomberg survey of nine strategists, a 1.9 percent drop since January. The index added less than 0.1 percent to 28,516.59 at the close, erasing an intraday loss of 0.8 percent.

The Sensex trades at about 16 times estimated earnings for the next 12 months, within 5 percent of a four-year high on March 3. The gauge is valued at 30 percent premium over the MSCI Emerging Markets Index, data compiled by Bloomberg show.

Investors’ waning enthusiasm for Indian stocks contrasts with bullish views toward the nation’s bond market, with global investors pouring a record $26.9 billion into rupee-denominated debt in the fiscal year ended March 31. Central bank Governor Raghuram Rajan left interest rates unchanged on Tuesday, after cutting them twice this year as oil’s rout cooled inflation.

India Story

Despite the reduced outlook for earnings and stock-market returns, analysts in India are still more bullish than many of their emerging-market peers.

Their forecast for fiscal 2016 earnings still amounts to a 26 percent gain from current levels. Profits in the MSCI Emerging Markets Index are projected to increase about 8.7 percent. The Sensex would climb to a record high if it matches strategists’ average year-end target.

“There’s still a lot of confidence in the India story,” Adrian Mowat, the chief Asian and emerging-market equity strategist at JPMorgan Chase & Co. in Hong Kong, said in an interview with Bloomberg TV India on March 31. “We have accelerating growth, prospects of lower interest rates and good quality companies.”

So far, the earnings recovery has failed to materialize. Sensex profits in the three months ended December fell for the first time in six quarters.

Oil Slump

That’s partly due to the deteriorating outlook for commodity-related companies after oil and metals prices slumped, according to ICICI Prudential Asset Management Co., which oversees $22 billion as India’s second-biggest money manager. Metal and energy companies have a combined 13 percent weighting on the Sensex, and contributed about 40 percent of the gauge’s earnings in the December quarter, the data show.

“Everyone dislikes the word inflation, but inflation adds to corporate profitability,” S. Naren, the fund’s chief investment officer, said in Mumbai on March 25. “We are not bullish on earnings improving in the next one or two quarters.”

Meanwhile, Modi has faced challenges in gathering the support needed to push through economic reforms. The BJP won only three of 70 seats in Delhi elections in February, its first electoral setback since Modi took power.

The defeat has added pressure on Modi as he seeks to push laws through the upper house of parliament, where the BJP lacks a majority. One of the key pending bills would make it easier for companies to buy property, among the biggest hurdles to investing in India.

Modi has so far used his executive powers to temporarily enable states to acquire land, and needs a majority in the upper house to make it permanent.

Investors who “enthusiastically” bought into local stocks in the last 12-18 months are now anxious, Saurabh Mukherjea, the head of institutional equities at Ambit Capital Pvt. in Mumbai, said in an interview with Bloomberg TV India on March 31. “The earnings growth pickup, the GDP growth pickup isn’t quite there.”

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