A confluence of unfavourable factors has emerged lately that could hurt the appetite for riskier assets such as equities. Cases in point include rising US bond yields and a strengthening US dollar index, which reduce the attractiveness of stocks, amid worries of a global recession. For the first time since October 2007, the US 10-year bond yield soared to touch 4.5% on Monday.
After the US Federal Reserve’s monetary policy decision last week, the narrative of higher-interest rates for longer has strengthened. Also, Fed’s dot plot suggests that the quantum of rate cuts expected in 2024 is now lower than earlier anticipated. In general, emerging market equities are seen as more vulnerable to higher interest rates. So, foreign investors may seek refuge in relatively safer assets such as the US dollar.
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Encouragingly, Indian equities have beaten Asian peers so far in 2023. But we have our own unique problems. For one, rising crude oil price tends to have many repercussions for a net oil importer like India such as upward pressure on the current account deficit (CAD) and inflation. In a report on 21 September, Kotak Institutional Equities’ analysts said they see fresh headwinds to the Indian market. “In our view, higher-for-longer interest rates in the US may provide headwinds to recovery in IT sector revenues; higher global oil prices may reverse some of the sharp recovery in profitability seen over H2FY23-Q1FY24; and weaker-than-assumed tax collections and CAD may limit the flexibility of the government to support the economy,” said the analysts.
Against this backdrop, it is understandable that foreign fund flows into the Indian equity market have turned negative in September after six months of continuous inflows (See chart alongside). Taking cues, the benchmark Nifty 50 index has given up some gains from the peak of 20,000 mark, closing at 19,674.55 points on Monday. To be sure, domestic institutional inflows continue to lend support to benchmark indices, protecting a steep downside. But in any case, life was not going to be easy with Brent crude price over $90 per barrel. Among other things, high oil prices are not desirable for companies that use crude or its derivatives as inputs. If oil persists higher for an extended period, it remains to be seen if companies would pass on that burden to consumers. If not, then profitability could come under pressure again for India Inc. According to Saurabh Jain, head, wealth management at Standard Chartered Bank, apart from persistent inflation, a downgrade of lofty consensus FY24 Nifty earnings per share estimates is among the key downside risks in the near term.
That is not all. A weak monsoon season and the resultant impact on inflation would be crucial to watch. Further, falling reservoir levels could hamper the upcoming Rabi crop sowing, translating to elevated food inflation. Clearly, this will have a bearing on Reserve Bank of India’s (RBI) monetary policy decisions and the Street’s rate cut expectations. RBI is expected to maintain status quo on rates at its next meeting.
Also, there is a looming threat that the ongoing India-Canada feud, if it stretches for a long period, may turn out to be a sentiment dampener, especially for long-term foreign flows. These concerns make India’s valuation discomforting. India’s one-year forward price-to-earnings multiple at 19x is higher than the last decade average of 17x, said Kunal Vora, head of India equity research at BNP Paribas. Midcap and small-cap valuations have got stretched but large-caps look reasonably placed, especially in sectors such as financials which have under-performed, he added. For mid-and-small caps, if the elevated earnings growth expectations in Q2FY24 are not met, there is a risk of sharp de-rating.