‘Growing disconnect between fundamentals and market valuations’

The upside in equity markets going ahead would be limited due to rich valuation across sectors despite weak consumer demand and slowdown in IT outsourcing services.

Highlighting the growing disconnect between fundamentals and narrative, Kotak Institutional Equities in a report said the equity market could see consolidation for a while with rich valuations capping upside while other positive factors likely protecting downside.

While rich valuations remain a major headwind, the macroeconomic outlook appears reasonable and corporate profits are expected to recover in the medium term on a fall in input costs.

The inflation, current account deficit and balance of payment appear to manageable although these factors can turn quickly given India’s vulnerability to domestic food and global fuel shocks, said the report.

Investment demand steady

In fact, these macro indicators have seen a sharp increase in the past few weeks. While consumption continues to be sluggish, investment demand is holding steady, it added.

The rich valuations of almost all consumption, investment and outsourcing stocks suggest high optimism among investors on eventual recovery in volumes, profitability in the short term and sustained financial returns of companies in the medium term.

Kotak Institutional Equities expects the profitability and returns of most consumption companies to come under sustained pressure over the next few years, which will weigh on their rich multiples. Lastly, there is hardly any margin of safety to absorb any potential negative events, it said.

The June quarter corporate results have shown continued demand weakness for automobiles and consumer staples with no visible recovery in rural demand while IT services lagged even modest expectations.

Investment demand continues to be strong among capital goods companies, showing robust growth in both order inflows and revenues, and cement companies reported double-digit volume growth. Profitability increased across sectors led by stable-to-higher product prices and lower raw material prices, it said.

Net profit and EBITDA of the Nifty-50 companies increased 30 per cent year-on-year and 14 per cent y-o-y. The bulk of the outperformance was due to higher-than-assumed other income in several cases. The report expects the net profit of the Nifty-50 companies to grow 16 per cent in FY24 and 13 per cent in FY25.