Bearing the dilemma of improved macro and unchanged micro

The market has lapped up the recent improvement in India’s macro peaking interest rates and better external position. However, the micro continues to be unchanged. The improved macro, analysts believe, percolates into better micro over the next few months. The fourth quarter results and management commentary underscored subdued domestic demand in consumption and weak global demand in the outsourcing (IT) sectors. The global inflation outlook has improved in recent months, as a result of monetary tightening across major DMs, a Kotak report points out, although the core inflation has stayed high. The progress on inflation has allowed the US Fed to pause its rate hike cycle, but bond markets are pricing in cuts after a brief pause. Experts believe the growth outlook may weaken as DM central banks may keep rates at peak levels for an extended period of time. Economic conditions are still fairly strong in most DMs.

India’s macroeconomic outlook has improved with peaking inflation, a comfortable inflation trajectory and an improving external sector outlook. The country’s interest rates may have peaked in the current cycle, which may address concerns about the negative impact of higher interest rates on housing demand. The RBI had already paused its rate hike cycle in April amid hopes of moderation in inflation. The domestic micro remains subdued, with Q4 earnings slightly ahead of the analysts’ muted expectations. The beat is largely because of lower-than-expected tax rate in the case of RIL. The report notes continued weakness across most consumption categories in Q4, although lending remained robust. Outsourcing companies were impacted by a weak global demand environment. Moderate earnings growth over the next fiscal is expected, with low scope for earnings upgrades across sectors. One cannot rule out earnings downgrades in the consumer discretionary space, as the underlying factors for the current spell of weak demand may sustain for another 2-3 quarters. The market is trading at reasonable valuations compared with recent history and bond yields after lacklustre returns over the past 18-20 months. However, most ‘growth’ stocks, especially in the consumption, investment and outsourcing space, are trading at expensive valuations, despite increasing near-term demand issues and medium-term risks of disruption.

Financials remain reasonably valued and appear attractive in the context of a likely healthy credit cycle over the next 1-2 years. Hence, it was no wonder when researchers removed Devyani International from the mid-cap model portfolio, given the stock’s 21 per cent return in the past one month, which has pushed the stock price well above the 12-month Fair Value of Rs 160. In fact, one can expect a gradual recovery in domestic consumption over the next 2-4 quarters. This is despite the fact that valuations are at risk without a quick recovery. On the other, stock observers have removed ABB (200 bps) from the large-cap odel portfolio, given the stock’s extremely rich valuations. Furthermore, we continue to like ABB’s fundamentals and have a positive view on the investment cycle.