Expert Zone

Straight from the Specialists

As liquidity dries, time for fundamentals

By Mukesh Agarwal
February 1, 2014

(Any opinions expressed here are those of the author and not of Thomson Reuters)

The focus is back where it should be for equity investors – fundamentals.

In the past few years,  markets around the world have swayed to the wave of liquidity unleashed by central banks in a bid to get their economies back on track. The U.S. Federal Reserve, for one, was buying as much as $85 billion of bonds a month since September 2012. But that tap is beginning to taper with the Fed reducing purchases by $10 billion in January and another $10 billion in February.

We feel that this, together with a host of factors at home, sets the stage for a more sanguine approach to equities. I indicated in my note last month that we expect 2014 to be a year of fragile recovery for the Indian economy. The scenario will be similar for Indian equities.

There will be some improvement in GDP growth from around 4.8 percent this fiscal to 6 percent in the next, driven by implementation of stalled projects, debottlenecking of the mining sector, and higher external demand.

At the same time, the upside remains limited because the project pipeline has narrowed significantly. Further, the Reserve Bank of India’s stated stance of moderating inflation means interest rates will remain high in the foreseeable future. Banking credit growth has been sluggish this year and will continue to be so in the next fiscal.

That is why fundamentals and earnings will decide the course of the equity market from here on, rather than liquidity-driven momentum. The initial set of third-quarter earnings numbers appear to indicate as much.

Among others, the IT sector continues its growth streak – aggregate revenues are up an expected 26.5 percent year-on-year, while dollar revenues have risen around 13 percent, helped by the rupee’s 14.5 percent depreciation. Growth in dollar revenues was largely due to strong volume growth.

EBITDA (Earnings Before Interest, Taxes, Depreciation and Amortization) margins also improved 150 basis points (bps), or 1.5 percentage points, primarily due to the benefits arising from a weak rupee and improved utilisation rates. Going forward, the sector’s prospects look good as various metrics indicate a steady global recovery.

CRISIL’s parent Standard and Poor’s expects the United States to grow at 2.8 percent and the euro zone to come out of recession in 2014.

Aggregate revenues of FMCG companies are up around 13 percent, driven mostly by realisations amid pressure on volumes. For media companies, it’s up 20 percent, thanks to digitisation.

On their part, private banks have been able to maintain overall good asset quality and have posted a growth of 19 percent in net interest income (NII, or interest earned minus paid) and 21 percent in advances. Growth has been more in short-term than long-term borrowings, reflecting corporate aversion to new projects.

Private banks’ net interest margins have also come under pressure (down 6 bps over the previous quarter’s 3.89 percent) due to deterioration in the current and savings account (CASA) ratio. The weak corporate environment has resulted in significant pressure on growth in current account deposits.

Most of the results from the core sectors such as capital goods, infrastructure and construction are yet to be announced. At any rate, no fireworks are expected since many companies in these sectors have been facing significant challenges. While we do expect stalled projects to be implemented, these would take time to reflect in the earnings.

We also expect pressure on the asset quality of public sector banks to continue in this quarter.

Overall, there haven’t been many negative earnings surprises, but volatility in valuations cannot be ruled out going forward. Hence, investors would do well to shun beta and stick to basics.

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