Relatively high valuation of India’s stock market could impede outperformance: HDFC Securities

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India’s equity markets outperformed most major markets over the last two years. Now, as we look forward to 2023, India’s relative valuations appear to be an impediment to further outperformance, and while India will continue to attract foreign fund flows, there is a likelihood of more money going to other emerging markets, which are playing a catch up, according to analysts at HDFC Securities.

“India has always been operating at some premium. The premium has increased a bit; that poses some kind of a challenge on the valuation side. There is bit of discomfort on the valuation at the current level but not significant,” said Dhiraj Relli, MD and CEO of HDFC Securities during an interaction.

So far in calendar 2022, the BSE Sensex has risen over 7.4 per cent. In the same period, the Nasdaq index has tumbled 29 per cent. The MSCI Emerging Market index has also slipped 21 per cent this year.

Even as the Indian markets have outperformed, foreign portfolio investors have been big sellers in the domestic market in the backdrop of a sharp rise in interest rates by major central banks, including the US Federal Reserve, and the appreciation in the US dollar.

So far in calendar 2022, FPIs have sold Rs 1.27 lakh crore in Indian equity. But, the tide seems to be reversing in recent months. They bought shares worth Rs 36,239 crore in November and so far in December have been net buyers worth Rs 5,279 crore.

With corporates showing a recovery in earnings and the economy still expected to be among the fastest-growing major economies, FPIs are likely to remain net investors in India next year. But, more money could head to markets like China, given their underperformance this year and the expected pickup in the Chinese economy next year as the government lifts Covid restrictions there.

HDFC Securities analysts highlight other worrying factors for India. Core inflation remains entrenched at 6 per cent and is expected to ease only gradually. India’s current account turned to deficit (1.2 per cent of GDP) in the 2021-22 financial year and is likely to widen further to 3.3 per cent of GDP in 2022-23 and come in at 3 per cent in 2023-24. This will put further pressure on the Rupee, which has already depreciated over 9 per cent to the US Dollar.

A deep and broad US recession could also have an impact on India, given we are not fully de-coupled from the world economy, the HDFC Securities analysts observed.

The first six months of next year could be fairly volatile for global markets and investors should use this period to invest in the long-term opportunities in the market, they said.

“From a 12-18 months perspective, we are still able to find enough bottom-up ideas, which can give you a reasonable return,” said Varun Lohchab, head of institutional research at HDFC Securities.

BFSI (banking, financial services and insurance) remains the broking firm’s top sectoral pick; its preference is towards large private sector banks within this sector.

The banking sector has seen strong mid-teens credit growth in the last two quarters and that growth is expected to continue into 2023-24 financial year as well, the analysts say. Profits of banks and non-banking finance companies are expected to grow at a 26 per cent compounded rate over financial years 2022 to 2024.

HDFC Securities is also “cautiously optimistic” on the information technology sector. The largest risk for the IT industry remains the uncertainty in demand and deal finalisations next year, given the possible recession in the developed world.

However, “in longer term, IT remains a structure growth story as cloud adoption and digitilisation penetration grows,” the analysts said.

HDFC Securities is also bullish on sectors like building materials, infrastructure and industrials, given the government’s continued focus on capital expenditure spending. For industrials, it is factoring in improved execution on account of strong order backlog and easing commodity prices.

It is also positive on the real estate sector, pointing to the strong pre-sales growth seen by companies there.

The analysts are also bullish on the chemicals space as the China plus one story plays out.

“Long-term growth visibility is intact, backed by heavy ongoing investments in capex for specialty products and chemical synthesis expertise of domestic producers,” it said.

As commodity inflation eases, chemical firms are also likely to start seeing improvement in margins from the October-December quarter this year, the analysts added.

Easing of commodity prices is also seen having a positive effect on fast-moving consumer goods companies. HDFC Securities expects profits of FMCG companies to grow at a 13 per cent compounded growth over financial year 2022-2024. While volume growth has been weak this financial year, the urban demand is expected to improve henceforth, the analysts said.

While, there has not been “convincing evidence” of rural demand recovery yet, if it improves, there could decent upside to FMCG volume growth in 2023-24, they added.

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