The rally in bonds and equities of emerging markets post ‘Brexit’ referendum may slow down (if not reverse), according to Kotak Securities. This is due to a potential policy normalisation by the US Federal Reserve over the next few months and limited potential of accommodation from other central banks. Besides, Indian stocks have rallied so much recently that there is no attractive value left in the market, thinks Kotak Securities. “Fundamentals of the Indian market are good, but not as great as what stock prices make them out to be,” says a report released today. The firm expects modest future returns. It is difficult to find good opportunities in the Indian market given the current valuation scenario.
It expects the earnings for Nifty-50 companies to rise by 15% in FY16-17. Among the different sectors, cement, media and metals will be out-performers. Earnings for metals and mining sector are expected to rise by a whopping 51%. However, the low base effect for the sector has to be taken into consideration – earnings for FY15-16 fell by 20.7%. Earnings for cement and media are expected to jump by 46.7% and 32.9% respectively in FY16-17. Telecom and energy are expected to be laggards in Nifty – 50 with their earnings expected to decline by 9.7% and 3.9% respectively.
Sectoral Outlook: Kotak Securities does not have a very positive views on consumption, Information Technology (IT) and pharmaceutical sectors. Valuation in consumption sectors is very rich. In certain cases, they are ‘absurdly rich’ as per the report. It has worsened in certain external sectors like (IT) and pharmaceuticals.
Bond Markets: The bond yields in developed markets have fallen to low levels given the policies fallowed by central banks. The yield in bonds has not declined much. However, it hardly means that risks have declined. There is a difference in nominal yields for government bonds for emerging markets and developed markets. However, according to Kotak Securities, this is due to inflation differential due to which the ‘nominal’ benefits would be nullified in theory.
The world is flush with liquidity. A whopping US$ 26 billion has been invested in global equities and bonds in the past 3 months. Global asset prices have risen in the past 5-6 years due to sustained purchases of government bonds, corporate bonds and equities. In addition, low interest rate policies have added fuel. What would happen if the global liquidity were to reduce? This was a question that Kotak Securities sought to answer. They carried out a mental exercise to find out the valuation multiples of various sectors and high profile stocks in India? In order to do this, they assumed a cost of equity of around 12% and the long-term risk-free rate of around 7%. In several cases, this exercise fetched a 20-40% lower multiple. According to Kotak Securities, the current re-rating in Indian equities is due to analysts using ‘global cost of equity’ as opposed to cost of equity for Indian markets as bond yields have come down dramatically in developed markets.
Markets are looking at the direction of US Federal Reserve policy to sustain the recent market rally. The US economy has gradually strengthened, especially in the area of employment. With this along with US Fed governors’ comments, the global markets have marginally recalibrated their expectations of an increase in US Federal Reserve rate. Kotak Securities has pegged the probability of US Fed rate increase by December 2016 at 44%.
Changes in Model Portfolio
Kotak Securities has dropped Tata Consultancy Services (TCS) from its model large-cap portfolio due to expensive valuations as compared to other Tier 1 names. Earnings and revenues in dollar terms for the sector have remained relatively stagnant. It added Indigo (InterGlobe Aviation) and transferred Petronet LNG to this portfolio. It also reduced Indian Oil Corporation’s weight in its portfolio.
It has entirely dropped its recommended mid-cap portfolio on valuation concerns as there is not much upside left for stocks in its portfolio. Out of 11 recommended stocks, five stocks were trading either above or close to 12-month fair valuations. It has not created a portfolio with a small number of mid-caps as it believes that a basket approach works best for mid-caps. According to Kotak Securites, only some stocks in infrastructure and real estate sectors offer some meaningful upside from a 12 month time horizon.