The coming months will be “a real test” for the economy and the markets as El Nino impact on crops, food inflation are further expected to add to the existing misery of the Indian market, broker Prabhudas Lillladher said in its mid-year ‘India Strategy’ report.
“The market seemed well poised for steady growth in the long run, however, the coming months will be a real test,” said analyst Amnish Agarwal of Prabhudas Lilladher, cutting the firm’s year-end target on the Nifty 50 index to 20,735 compared to the current value of 19,440.
“We expect markets to consolidate ahead of 2024 elections and advise stock specific approach and avoiding sectors/companies with weak fundamentals and lack of business moats,” it noted.
INFLATION
One of the key factors that are likely to pose a risk to the Indian economy in upcoming months is inflation, the report said.
It predicted that the inflation for August 2023 would still remain high at 7% with a surge in food prices including vegetables and staples remaining at peak levels.
However, the broker stated that it believes the food inflation pressures could recede gradually if kharif outputs remain intact, although monsoons over the next month and a half remain a critical factor.
In July, India witnessed a surge in consumer price index inflation, reaching a 15-month peak at 7.44%, a significant jump from June's 4.81%. The surge in July’s inflation was mainly due to an inflation spike in food prices, it noted.
However, “inflation isn't solely attributed to vegetables, especially tomatoes. Instead, a wider range of food items, including cereals, pulses, and spices, have contributed to the price pressures,” the report noted.
Adding to inflationary pressures are risks of irregular weather and rainfall patterns, which also played a part in mid-year spike in tomato prices. While tomato prices have begun to come down, it could take another month for the downward momentum to gain pace.
Staples like cereals and pulses are unlikely to offer relief in the near term amidst hardening international prices and subdued sowing domestically.
“We expect administrative interventions by the government to intensify further to curb price pressures for select food items. This should help push headline inflation below the upper tolerance threshold (of 6%) from July to September period in FY2024 onwards,” the report suggested.
HIGH INTEREST RATES
The dim possibility of a further cut in interest rates with some possibility of interest rate hikes in the second half of the year was another major reason.
"We believe the Monetary Policy Committee (MPC) will overlook the temporary spike in vegetable prices and maintain the current repo rate throughout FY24," the report stated.
In the event of inflation staying elevated for longer, the MPC may consider a 25 bps hike to guard against the generalization of price pressures, however further cut in interest rates looks unlikely for the next 2-3 quarters.
However, the report applauded the Nifty gains which registered a strong growth at 14% return to date in FY2024. This was possible due to high foreign investments in the Indian market which was valued at more than $16.5 billion.
The April-June quarter in FY2024 emerged as the first normal quarter after the Covid-19 pandemic in 2020.
RURAL DISTRESS
Another key factor that is dragging markets is the financial distress in India’s rural economy.
Rural demand has been muted for nearly a year, which has impacted the performance of companies in sectors such as fast-moving consumer goods, retail and automobiles.
However, Prabhudas Lilladher said it is showing faint signs of recovery and urban discretionary demand remains tepid. The demand scenario is mixed, with some green shoots in 2-wheelers and FMCG in rural India, the broker said, referring to the performance of companies in the April-June period.
Urban discretionary spending shows a seasonal uptick in QSR, price correction led growth in Jewellery while most discretionary segments are depressed. However, travel, tourism, and spending on marriages continue to show strong growth.
Meanwhile, Union Govt-induced capex is giving a big push to the economy.
LIQUIDITY
An expected interest rate hike in the US and its impact on the rupee and dollar can impact capital flows, it added. The markets may also react negatively if there are chances that the ruling front faces challenges in coming back to power in next year’s elections.
“We expect markets to start factoring in political risks as election-related activity picks -up with state elections in November and Lok Sabha elections in April 2024,” the report stated, adding that the firm remained positive on auto, banks, capital goods and healthcare.
FIRST-QUARTER PERFORMANCE
The broker highlighted the strong performance put up by sectors such as capital goods, pharma and travel during the first quarter of the financial year (April-June), pointing out that companies in these sectors have given maximum beat in sales.
On the other hand, agri and speciality chemicals have been the worst performers with an 8-10% decline in sales.
When it comes to profitability, auto, pharma and travel have put up the best performance, while specialty chemicals, agri, and building materials saw 6-26% lower EBIDTA than estimates.
Capital Gods, Durables and Staples were largely in line, the broker pointed out.
FUTURE BETS
The broker said it is overweight on auto, banks, IT services, capital goods and healthcare.
It is underweight on metals, cement, consumer, oil & gas and diversified financials.
We are making minor changes in weights but sectoral calls remain same, it noted.
The broker added SBI, Gujarat Gas and Navneet Education in its list of high conviction buys, while removing HDFC Bank from the list.