There are roughly four developments that historically helped the domestic stock market reach bottom post credit events. They included easing of valuations, a sharp plunge in US 10-year yields from high, large rate cuts by the US Fed and ECB; and earnings downgrades of 15-20 per cent, said Nuvama Institutional Equities. In the current context, it would mean India’s market cap-to-GDP ratio falling to 60-70 per cent level against 92 per cent at present, Nifty spread with 10-year US bond yield widening to 6-7 per cent from 2 per cent and earnings getting downgraded by over 15 per cent from just 5 per cent so far.
These milestones are still distant as compared to history, Nuvama said.
The collapse of SVB and Credit Suisse has raised the spectre of potentially another crisis. But Nuvama Institutional Equities noted that the current crisis is more an outcome of excessive tightening resulting in asset-liability mismatch. It feels the scale of the problem this time is much lower. That said, the monetary backdrop in the run-up is much more adverse with yield curve in deep inversion and global broad money supply growth being much weaker compared to the past, it said.
“To that extent, a larger easing is warranted. Also, unlike in the past, US fiscal firepower and China’s monetary muscle are much more impaired. Hence, if the current crisis left unchecked, could result in larger economic fallout,” Nuvama said.
Nuvama said even prior to the credit event, it was concerned about earnings outlook. The credit event only accentuates the same, it said.
Earnings downgrade
Nuvama said global M1 (money supply) is one of the best lead indicators for Nifty earnings, given its strong global interlinkages.
“It suggests a sharp moderation in Nifty earnings. This could disappoint consensus forecasts of 18-20 per cent earnings growth. Historically, during GFC or European debt crisis, Nifty earnings have been cut by 10-15 per cent before markets have bottomed. So far, we are far from that and hence earnings cuts need to happen. Hereon expect demand led earnings downgrades. In such an environment, falling input prices alone are not enough to support margins,” Nuvama said.
Easing valuations
Nuvama said markets have bottomed out in the past when market cap to GDP has been around 60-70 per cent and one-year forward Nifty PE stands to 12-13 times. While the market cap-to-GDP stands at 92 per cent and forward Nifty PE stays at 18 times. Besides, during global slowdowns, India’s valuation premiums to the world typically tend to compress. Today, they are at very high levels, to a large extent owing to the significant outperformance in 2022, suggesting valuations are down but not cheap.
Interest rate cuts
In the case of rate cuts, Nuvama said markets tend to correct during initial rate cuts, its only when policy response reaches critical mass do markets stabilise. ECB raised rates by 50 basis points recently and a Fed rate hike is on the cards later today.
Ease in bond yields
Nuvama noted that 10-year bond yields down 50 basis points from their peak. But given the global growth scenario, they should ideally be at least 200 bps lower, it said. As growth outlook is likely to worsen, owing to the fallout of global banks, it expects US 10-year bonds to fall even more. In the initial phase, this may not augur well for equities, Nuvama said.
“The rally in USTs initially happens due to risk aversion, but later due to reversal in Fed’s stance. The rally has to be of such magnitude that it eventually cheapens equities,” it said.
Stocks to buy
IT sector has been feeling the heat of global recession risks for more than a year now. But despite the increasing risks of US banking system, Nuvama has raised its weights on the sector given the cash rich balance sheets. It said IT tends to outperform during global crises. This is owing to fact that it gets support from rupee depreciation and its cash rich business model as compared to domestic cyclicals, which are impacted by tightening liquidity.
Apart from IT, Nuvama is raising weights in cement as it finds it more like consumer good rather than commodity in India that benefits from falling input prices. The brokerage also likes pharma that it thinks should be a great defensive in the current environment.
Nuvama said it is now turning further cautious on the BFSI sector as it thinks there are more downside on margins, growth and credit costs. Nuvama is also underweight on industrials for sometime. This is because Industrials are likely to be the most adversely hit in the current macro-environment.
“Also, lower government tax revenues could weigh on industrial companies’ working capital cycles as well. Historically, they have underperformed during global slowdown. This time around, both recovery and downturn has been more delayed, perhaps owing to delta wave,” it said.
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