World-Beating Stock Rally Hinges on Corporate India ProfitsBy and
Gap between share prices and earnings has widened since 2014
Equity valuations rose to highest level since 2010 in March
The fate of India’s world-beating stock-market rally hinges on a routine event: earnings season.
Equities are trading near record levels in Mumbai, bolstered by bets that a state election victory will embolden Prime Minister Narendra Modi to push ahead with his reform agenda. Valuations rose to the highest level since 2010 at the end of March and the S&P BSE Sensex index is the top-performing gauge this year among the world’s 10 biggest stock markets.
The gap between share prices and company profits has widened since 2014 on expectations economic growth will filter into bottom lines. That hasn’t happened consistently -- while India’s GDP expanded 7 percent or more in each of the last four quarters, Sensex profits fell in two of those periods amid a tepid investment climate and rising bad loans.
“The return expectations have to moderate,” said Mahesh Patil, who helps manage about $30 billion in assets as co-chief investment of Birla Sunlife Asset Management Co. “If expectations are more realistic, the market should be able to deliver that in the medium term.”
Earnings season kicks off Thursday, when software developer Infosys Ltd. is scheduled to report. Company results will show performance during the first full quarter since Modi ordered a recall of high-value currency notes in November in a bid to reduce graft.
Sensex members will post a 9.1 percent increase in net incomes for the three months ended March, helped by higher commodity prices, Deutsche Bank said last week. That would be the biggest quarterly climb in a year, data compiled by Bloomberg show. The gauge dropped 0.5 percent to 29,642.89 at 9:58 a.m. in Mumbai.
Birla’s Patil expects profits to recover only in the second half of the year that began April 1. Better rains, along with government programs and reforms, will help boost economic growth in rural India, he said. Patil said he is bullish on financials, including mortgage lenders, and consumer discretionary companies.
Morgan Stanley sees a similar trajectory for earnings, albeit over a longer time horizon.
“Growth is in a U-shaped recovery driven by domestic and global factors,” Sheela Rathi, an analyst at Morgan Stanley wrote in a note dated Monday. She projects Sensex profit growth of 18 percent in fiscal 2018 and 24 percent in 2019.
Both domestic and offshore investors are betting on that. Overseas funds bought $6.7 billion of stocks in the first quarter, the most among major Asian markets, and local funds were net buyers for a 12th straight quarter, data compiled by Bloomberg show.
“With the macro picture turning positive, the earnings growth trajectory over the next few years can surprise you on the positive side,” Birla’s Patil said. “But, the broader market will remain expensive because of the high liquidity.”
— With assistance by Adam Haigh, and Jeff Sutherland