Top 5 factors why 2015 will most likely be a weak year for Indian equities

NEW DELHI: The euphoria that had gripped the market after Narendra Modi stormed to power last year is on the wane, and Indian equities may have to adjust to realities in the form of weak corporate earnings and sluggish pace of reforms. In this backdrop, 2015 is likley to be a subdued year for the markets, which had returned 30% gains in calendar year 2014.

The S&P BSE Sensex is up a little over 12 per cent in the last one year, while it is flat on a year-to-date basis. The year 2015 started on a positive note on hopes of pro-growth reforms by the Modi-led government and revival in investment cycle.

However, disappointment over the pace of economic revival and sluggish corporate earnings weighed on sentiments, reflecting in the recent drop in the stock market.

Not just domestic, but global factors also weighed on sentiments. As a result, the Sensex came down over 2,000 points from its record high of 30024.74 recorded in March.

"It is going to be a weak year for India in the equity markets in terms of profitability, earnings and also in terms of the returns," says Kunal Ghosh, Portfolio Manager, Allianz Global Investors.

"We will have a long lull in earnings but it is a good opportunity for long term investors, because India is going to become a secular story based on infrastructure and capex," he adds. Ghosh is of the view that it is time to build up on India during this lull triggered by the sell-off.

Most foreign brokerages might have slashed year-end target for both Sensex and Nifty, but the long-term story still stays intact and investors with a long-term horizon can look at accumulating quality stocks on dips.

So far, 2015 is shaping up differently to what many had expected at the start of the year. India remains a market where investors have high portfolio exposure, but risk to growth is rising.

We have collated a list of five factors which might weigh on markets in the year 2015:

Bounce back in earnings growth only by H2/2016:

As expected, earnings for the quarter ended March 31 started on a muted note, and analysts are of the view that it will take another three-four quarters for earnings to show pick-up. This is leading to weakness in the markets.

"We were on the consumer gear, and now we are shifting to the infrastructure and the capex. It will have a lag of around 12 to 18 months at least. So, we should not expect the earnings in Nifty to show up till the middle or the second quarter of calendar year 2016," says Ghosh.

38 out of the 50 Nifty companies that have declared results so far have led to an aggregate downtick of 55 per cent in net profit. According to experts, the next leg of the rally will be led by recovery in earnings, which, according to analysts, is not visible at this point of time.

"I would say that the whole earnings recovery process has probably got extended, perhaps by a couple of quarters. Nobody expected earnings recovery to happen in any big-bang manner. Clearly, market participants believe that Q1 FY16 is going to be the breakout quarter. That is when the recovery will start," says Nilesh Shah, MD & CEO of Envision Capital.

"That has perhaps now got pushed by a couple of quarters. So, instead of Q1, I believe that the recovery process in earnings will start somewhere around the end of H1," he adds.

Other emerging markets are looking attractive:

Chinese equities caught the fancy of investors around April, primarily because the government allowed the Chinese mutual funds to buy Hong Kong stocks, so those stocks soared. FIIs in India were sitting on huge profits, and that pushed some bit of profit booking in Indian markets, say experts.

Ghosh is of the view that the immediate flows are all being attracted by China, which is not based on economics, but it is more from the liquidity movement of the KONEX and freeing up of the Chinese market between Shanghai Shenzhen and the Hong Kong. So, that is where one of the attraction lies. So, there is somebody who is looking prettier than India now, he adds.

Even the Chinese Central Bank is on the loosening path, so FIIs have taken profit and played that on that theme, experts suggest.

"Foreign investors might be taking out some money from Indian shores but the bottom line for us is that those kind of rotations will happen, but ultimately liquidity will follow fundamentals," says Rana Gupta, Managing Director (Indian Equities), Manulife AM.

"Indian fundamentals over medium to long term look good, so money will come back, though at a later point in time," adds Gupta.

US Fed rate hike:

Recent macro data from the US fuelled concerns that US Federal Reserve could hike rate sooner rather than later. Reports on Tuesday showed that US business investment spending plans increased solidly in April, consumer confidence perked up this month and house prices extended gains in March.

"The buoyant data comes after Federal Reserve Chair Janet Yellen said on Friday that the central bank could raise interest rates this year," Reuters reported.

"The US rate hike, whether it happens in July or September, is the most discussed factor priced in the market. Now as and when the rate hike happens, there will be transient volatility," said Rana Gupta, Managing Director (Indian Equities), Manulife AM.

According to Gupta, as and when the final hike happens, it would be more like the news playing. So transitory impacts can happen, but no medium to longer term impact is expected.

FIIs trimming overweight stance on Indian markets:

Indian markets came under pressure in the last two months of the calendar year 2015 as some of the global emerging market funds (GEMs) have offloaded some of their overweight stance on India markets, to invest in other emerging markets such as China that have started performing.

HSBC says that India's weight in global emerging market (GEM) funds saw a sharp fall after reaching the highest level in January 2015. A combination of profit booking on India coupled with performance elsewhere, especially China, led to contraction of India's weight, said the HSBC report.

In GEM funds, weights fell from 11.0% to 9.7%; while in Asia-ex-japan (Asia, excluding Japan) funds, India's weight fell from 8.9% to 7.6%. However, global funds increased India's weight from 0.9% to 1.0% - the only exception to the trend.

Foreign Institutional Investors (FIIs) remain overweight on India in general, but it seems like they are trimming their position, UBS said in a report last week. The global investment bank met nearly 100 investors from the US, the EU, and Asia in the last month.

Some of the foreign brokerage firms have flagged concerns over Indian markets in the short term, largely on account of earnings growth, which will take a couple of more quarters to bounce back, weak currency, monsoon woes, rise in crude oil prices, slow reform process, tax concerns (MAT) and other emerging markets which are looking more attractive.

Brokerages slash December-end target for benchmark indices:

Both Citigroup and HSBC have trimmed their December-end target for the Sensex last week, largely on account of softer earnings in near term with delayed reforms and an existing overweight stance for FIIs on India.

Citigroup in its latest report adjusted its December-end target for Sensex to 32,200 from 33,000 earlier to factor in earnings cut. They have also introduced a June 2016 target of 35,000. The equivalent Nifty targets are 9,760 for December 2015 and 10,600 for June 2016.

After turning underweight on Indian markets, HSBC slashed its Sensex target earlier this week for the calendar year 2015 to 26,900 from 30,100 earlier. HSBC expects India's current PE to contract further to 15.5x (from current level of 16.5x) to account for the near-term headwinds.

UBS slashed their Nifty target for December 2015 to 9,200 from 9600 earlier, to reflect earnings cuts. "We now use a higher multiple of 17x one-year forward PE (vs 16x earlier) as we expect current multiples to likely sustain," said the report.