Vijay Kumar Gaba

The Indian economy has grown 9.7% (yoy) in 1HFY23, as compared to 13.7% growth recorded in 1HFY22. Given the consensus growth forecast for FY23 is around 7%, the implied growth rate for 2HFY23 is close to 4% (yoy).

Further the forecast for FY24 are veering around 6.2% (ranging from 6% to 6.4%), given the rising global slowdown hitting exports further; lagged impact of monetary tightening likely hitting in 1HFY24; investments slowing down on poor demand growth visibility and persisting high inflation further hitting domestic savings.

It is therefore likely that the Indian economy might grow less than 5% for the next four quarters. This will be the period that may see a very high decibel drama in the global theatre. The current trends indicate that the monetary tightening by the US Fed and other global central bankers has already started to impact the demand and employment. The consumer demand, housing starts, and high paying jobs are showing a distinct downward trend. Similar trends are also visible across Europe. Easing bond yields, despite likelihood of further hikes and tightening by the central bankers, at least till 1Q2023, is clearly indicating a notable slowdown in the global economy in 2023.

The long term growth trend (5yr CAGR) continues to remain below par.

2QFY23 GDP data had some trends that should worry markets. For example—

• Industry sector growth contracted by 0.8%, mainly led by decline in manufacturing activity (-4.3%).
• Government consumption contracted 4.4%, while private consumption was also lower YoY as well as sequentially.
• Exports continued to slow for the seventh consecutive quarter. 2QFY23 export growth of 11.5% was the lowest post pandemic. Net export is likely to come under further stress given the looming global slowdown, which would likely dent global demand further.
• Services growth (9.3%) was also lower YoY (Q2FY22-10.2%) and sequentially (1QFY23-17.6%), mainly dragged by community and defence services.
• Subsidy disbursement was poor, while tax collections were strong, resulting in lower GVA growth of 5.6%.
• The Gross Domestic Savings (GDS) at 26.2% of GDP in 1HFY23 is the lowest in two decades.
• The April-October 2022 fiscal deficit is reported at 45.6% of FY23BE. This materially higher as compared to 36.3% in the similar period of FY22. This number read with higher tax collection, lower government consumption, lower subsidy distribution and sharp rise in government investment implies that 2HFY23 could see slower government capex.

Besides the economic data, the market fundamentals are also indicating headwinds for markets in the next few months. For example—

• The present spread between 10yr US Treasury yields and 10yr GOI Treasury Yield is ~3.4%, which is lowest since the global financial crisis (2009). Given the negative BoP forecast for FY23, the USDINR may continue to be under pressure, further narrowing theoretical arbitrage for foreign USD investors. The foreign portfolio flows could be impacted if this spread sustains or narrows further.
• NSE500 EBITDA Margins at 15.7% during 2QFY23 were the lowest in ten quarters. Thus despite 29% yoy growth in sales, NSE500 PAT declined ~3%.
• Net FPI selling in YTDFY23 has declined to ~US$3bn; but the domestic flows are showing some signs of tiring. With domestic savings declining and household finances under pressure, the domestic flows may likely be moderate in the next few months at least.
• Nifty is trading at ~10% premium to its long term average one year forward PE multiple. Since, the current estimates of EPS are elevated and likely to be downgraded further, this premium could actually be higher.

I shall continue to remain cautious and not get swayed by the recent up move in the markets. I believe that the market shall provide much better entry points in the next few months. Insofar as my current portfolio is concerned, I am maintaining my standard asset allocation for now (see here). However, I would like to raise some tactical cash if the markets rally further from the current levels.

 It was an unusually warm winter in the European continent in 1989. The western pacific was unusually warm due to El Nino conditions. Demolition of the Berlin Wall had just started. Under these settings the US President George Herbert Walker Bush and USSR General Secretary Mikhail Sergeyevich Gorbachev met at Malta, an archipelago in the central Mediterranean between Sicily and the North African coast, to discuss the end of the Cold War. The summit marked a watershed in the East West relationship. The summit was followed by formal end of cold war, completion of nuclear disarmament in pursuance of INF Treaty (1987) and dissolution of USSR in 1990-91. The apparition of the Second World War was finally liberated. The world looked forward to an era of peace, cooperation and progress ahead.

The two decades that followed 1990 would see unprecedented growth in global economics. Global trade and commerce flourished. The highest number of people got elevated from poverty in the third world countries across Asia and African continents. Information technology advancement revolutionized the way people worked and lived.

We could find many instances in history to show that when two arch rivals decided to bury the hatchet, the event marked the beginning of a new era of progress.

In business parlance, conventionally it is believed that when the largest competitors decide to merge their operations, it is usually marked by the end of a decline business cycle; even though beginning of a fresh ascending business cycle might not immediately happen.

The recent deals between Zee Entertainment and Sony Pictures Network; and PVR and INOX Leisure, in my view, are indicative of the tide ebbing in the Indian entertainment industry. The consolidation in broadcasting and exhibition businesses would create few mega players with a larger pool of resources and reach to face the threats from alternative sources like social media and pure OTT platforms. Of course, the improvement in the business conditions and profitability may not happen immediately, it is highly likely that the future of the Indian entertainment industry is much better than it would have been otherwise.

Overall market also seems to have begun to assimilate, though reluctantly, the tougher business conditions and growth challenges. The adjustment may be two dimensional, like always. First, the poor liquidity, higher bond yields and slower growth would require PE multiples to be derated (revised downwards). Second, margin pressures due to higher raw material and wage costs and lack of pricing power due to poor demand; and lower profitability due to higher cost of capital and lower capacity utilizations would warrant earnings downgrades.

Obviously, the 25-30% earnings growth forecasts for FY22-FY24 looks difficult to meet. From this point of view, the “fair value of Nifty” argument would require reassessment from both the angles – (i) achievable earnings growth; and (ii) sustainability of earnings growth trajectory.

In my view, both Nifty and Nifty Midcap might be trading very close to their fair value based on likely FY23 earnings. Any upside from the current levels would depend on the higher visibility of FY24 earnings. At the same time, I would not be worried about any sharp (15% or more) correction from the current levels, given the visibility of FY23 earnings and bond yields.