India Will Underperform Emerging Markets in the Short Term: “Risk of ‘Spreadover’ Is Greater in Indian Market…”

The stronger impact on the domestic stock exchange was partly due to our playing with a weak wicket. In the previous weeks, the domestic market performed weaker compared to other emerging countries.

The poor performance deepened as investors began shifting funds to Asian peers such as China, seeing much lower valuations – 10 to 25 times higher forward P/E on a dollar basis compared to premium valuations in India.

India has been trading at a premium for a long time due to its economic dominance. However, recent corporate earnings growth has stabilized and is trending negative, indicating that India will face a valuation adjustment.

Read also: Stock Market Crash: Israel-Iran War to FII Outflow – 5 Reasons Why Sensex, Nifty Dipped Today Amid Volatility

Rising tensions in West Asia have had a disproportionate impact on the Indian stock market compared to the global crisis. Since September 26, the Nifty 50 index has fallen by 4.5%, while the major global indices have fallen by just 1.25%, except for China, which has risen by over 10%.

The world is doing better, and given India’s dependence on oil imports, the sharp rise in oil prices translates directly into India’s trade deficit. With oil prices rising 10 percent, the resulting volatility affects both currency and stock markets.

We maintain that in the short term, India is likely to underperform other emerging markets, with mid-cap stocks lagging domestic large-caps. This change in our worldview was already taking place before the recent Israeli-Iran conflict, which only exacerbated the situation.

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The increased tension is expected to raise uncertainty as Israel responds to the Iranian missile attack. The broader concern – or hope – is that this historic skirmish will not escalate into a full-scale war, with the United States playing a key role in the background.

The Ukraine-Russian war had profound economic consequences, severely disrupting global supply chains. Ukraine, an important supplier of key food commodities such as corn, wheat and edible oil to regions including China, has faced significant export challenges.

At the same time, Russia, a key supplier of oil, gas and metals to Europe, has felt the impact on goods flows. The war took place at a time (February 2022) when the world was already on fire due to low capacity utilization caused by Covid-19, affecting supplies and leading to hyperworld inflation.

Israel and Iran’s economic trade with the world market is largely limited due to the shortage of basic goods, which minimizes their direct impact on global inflation. But Iran is the world’s ninth-largest oil producer, and the collision occurs near key shipping lanes and an oil-trading region where oil prices are already soaring. This is expected to be negative for India, increasing the risk of underperformance.

Read also: Nifty 50 tumbled 4.4% this week, recording its biggest weekly decline since June 2022 on rising fears of war between Iran and Israel, FII outflows

Sectors in focus

The next key area of ​​interest in India will be the start of corporate Q2 earnings releases this week. It will start with the IT sector, which is expected to see a marginal improvement in earnings growth on a quarterly basis. Another question is whether they are good enough on a year-over-year basis to suggest a decently high current valuation.

The focus is coming from data centers, North America, the healthcare sector and ERP systems. Meanwhile, sector margins are likely to remain mixed due to deferred wage increases and budget constraints among customers, leading to cuts in discretionary spending.

Customers continue to tighten their budgets and reduce discretionary spending. Despite these challenges, there are signs of a gradual recovery in customer spending, particularly in the areas of modernization and discretionary. The outlook for BFSI is likely to improve as the US Fed is expected to cut interest rates to a good extent.

In the near term, the IT sector is likely to continue its growth trend, although at a slower pace. The sector has performed well over the last three years, reaching its highest valuation in three years, which is driving performance in the short term. Domestically, investment in this sector has attracted great interest given its defensive nature and is expected to continue.

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Banks, a key sector to start the session, take a muted view. Lower-than-expected central government fiscal spending and subdued growth in advances and deposits are expected to continue to pressure margins in the second quarter.

Industry progress is expected to grow by only 4.05% q-o-q, which is much less than the eight-percent q-o-q growth. achieved last year. Therefore, only a marginal improvement in bank profits is expected. Stress in the SME segment may lead to more delinquencies, resulting in higher than expected provisions, further compromising the bank’s profitability.

The start of the Q2 earnings season is expected to be mixed, with a negative bias. There is a risk of short achievements in the next 1-2 quarters. This could lead to price cuts as the market believes that earnings growth will return.

The first quarter was weak due to the effect of national elections. The market sentiment is that steady domestic demand, changing global demand and lower inflation compared to last year will support earnings growth in the future. This view will be tested in the second quarter.