India Strategy : Equity valuations stabilise as `unfettered inflation` argument weakens on retreating prices; Q1FY23 growth indicators robust - ICICI Securities
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1960s-80s type of structural rise in bond yields argument weakens as inflation is showing signs of slowing down: Key argument for a sharp downside in equity valuations is being driven by the extreme fear of a structurally rising inflation and bond yields like the one observed during 1960s-80s in the US, thereby, resulting in an environment of significant underperformance for equities. However, after the initial shock, due to the sudden escalation of Russia-Ukraine conflict, global commodity prices across the board have started declining along with freight rates, which weaken the structural inflation argument due to commodity prices. Also, the feared wage-spiral conditions are unlikely given the softening outlook for job market going ahead as growth moderates.
Although CPI inflation in the US has not yet started to decline, the equally important core PCE inflation continued to dip for May’22, while US 10-year bond yield dipped sharply to below 3% after spiking to almost 3.5% in Jun’22. India CPI also showed signs of slowing down in May’22.
On the other hand, high frequency growth indicators for Q1FY23 are robust for India so far:
* Strong manufacturing and services: Average PMI-Manufacturing at 54.4 and PMIservices at 58.4 for Q1FY23 (Apr-Jun’22) are robust. Export growth at 16.77% YoY for Jun’22 and GST collections at Rs1.45trn for Jun’22 are also robust.
* Core sector and credit growth improving: Core sector growth in May’22 was 18.1% YoY and non-food credit growth in Jun’22 was 12.6% YoY.
* Southwest monsoon has covered the entire country about a week earlier than the normal date of July 8th, as per the IMD.
* High tax buoyancy helps fiscal position although trade deficit continues to expand.
Valuations remain reasonable with ‘earnings yield’ of around 6% and ‘asset valuations’ in terms of P/B dipping below long-term average at 3x while aggregate ‘market cap to GDP’ ratio stands at around 100%. Other key trends include:
* Rising fear of a mild recession in the developed world going ahead.
* Strengthening of US$ puts downward pressure on most Asian currencies including INR.
* Additional duties/cess on petroleum crude, HSD, petrol and ATF will negatively impact the profit pool of energy sector, but will add to government financial resources that focuses on capex spend.
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