Indian stock markets, which have gained 40% over the last 18 months over the election of a strong government at the center, looks ripe for a deeper correction, a report by Business Monitor International (BMI – part of the Fitch Group) said.
“Indian equities are looking precarious, and a deeper correction looks highly likely as the ruling BJP government faces roadblocks in its reform agenda due to a lack of majority in the 245-seat upper house,” BMI said.
However, that is only half the story. “Corporate profitability remains poor and market breadth appears to be weakening,” BMI added.
In fact, after rising by about 40% in one year starting from February 2014 — when chances of a strong government at the center became clear — Indian stock indices have largely stagnated.
The Nifty, for example, touched the 9000 mark in early March, and has since then fallen back below the 8,400 mark.
“Over the past couple of months, Indian equities have been struggling to head higher, and we are increasingly cautious. A break below around 1,000 in the MSCI India index would likely trigger a leg lower for the index, and possibly a large downside move towards previous resistance-turned-support at around 850,” BMI said.
BMI said the going for the current government, headed by reform-oriented Narendra Modi, has been far from smooth.
“The rally in Indian equities since May 2014 has been due to investors’ optimism with regard to the business-friendly reforms enacted by the newly elected Indian government led by Prime Minister Narendra Modi from the Bharatiya Janata Party (BJP). While reform momentum throughout Modi’s first year in office was broadly positive, the BJP’s lack of a majority in India’s 245-seat upper house (holding only 48 seats) means that the ruling government will face significant opposition from the Indian National Congress (INC; which holds 68 seats) with regard to several key reforms in the coming year.
“We are already seeing signs of strong political opposition during the ongoing monsoon parliamentary session, which runs from July 21 to August 13. For example, the speaker of the parliament had to halt proceedings on the first day of the session as the INC demanded BJP leaders facing corruption allegations to resign,” it said.
BMI said it did not expect the land acquisition bill to be passed in the near-term, but was hopeful of the implementation of the Goods and Service Tax (GST) system on April 1 2016.
The GST bill was framed in the time of the Congress government, and it is expected to see less opposition from the Congress Party.
“(The) slowing reform momentum is likely to weigh on Indian stocks over the coming weeks.”
The second part of the problem has to do with corporate earnings, BMI said.
“In terms of valuations, Indian equities are looking relatively expensive, with the P/ E ratio of the MSCI India index currently standing at 21.7x,” it noted.
“We highlight that the increase in equity prices over the past year has been in the absence of increasing profits, and much of the optimism regarding reforms has already been priced in. In fact, despite broadly stable EBITDA margins, net profit margins remain on a downtrend, and are 1.8 percentage points below their 20-year average of 11.7%.
“Among the reasons for poor profits of Indian corporates are high interest costs, and depreciation and amortisation expenses owing to increased corporate debt. We do not expect debt-servicing costs to come down by a significant amount any time soon given that these companies are taking on more debt. Moreover, despite the Reserve Bank of India (RBI) cutting its repurchase (repo) rate by a total of 75 basis points (bps) since the middle of January 2015, Indian banks have only reduced their base rate by approximately 30bps.”
On the technical side, BMI said the number of component stocks trading above their 200-day moving average (DMA) is on a downtrend, and only about half of the components are currently trading above their 200 DMA.