Limited downside in markets provided inflation remains in check: Analysts

After a fall of nearly 5 per cent thus far in calendar year 2022 (CY22) on account of domestic and global headwinds, analysts now see limited downside for the markets provided inflation remains in check. On the contrary, those at Kotak Institutional Equities (KIE) expect a modest bounce from the current levels over the next few months if inflation data was to be in line with market expectations.

“The Indian market may have limited downside and even moderate potential upside over the next few months if inflation data was to be in line with market expectations. The valuations of the Indian market have become a lot more palatable over the past one-two months on steep correction led by steep increase in bond yields on inflation concerns and modest earnings downgrades in most consumption sectors on lower demand and profitability assumptions,” wrote Sanjeev Prasad, co-head, Kotak Institutional Equities in a recently co-authored note with Anindya Bhowmik and Sunita Baldawa.

Peaking of inflation, analysts believe, could put a cap on bond yields and a floor on equity valuations. On the other hand, a rise in inflation leading to higher-for-longer inflation expectations may result in further increase in bond yields. This in turn, they believe, can trigger a market correction. 
 

“Further rate increases by developed market (DM) and emerging market (EM) central banks would have limited bearing on bond yields (and by extension, equity markets) as long as inflation was to broadly follow the market’s expectations,” analysts at KIE wrote.

Meanwhile, valuation of the broad market, according to KIE, have become a lot more reasonable after the recent correction. The Nifty-50 Index, they said, now trades at 19.2X one-year forward net profit compared to a 12-month peak of 23x.

On its part, the Reserve Bank of India (RBI) has been targeting inflation via its monetary policy. Most experts see the central bank hike rates by another 50 basis points (bps) in its June policy meeting after a surprise 40bps hike earlier in May.

“With inflation poised to average 7.2 per cent y-o-y in FY23, we see a straightforward case for frontloaded hikes. Expect a 50bp hike in June and a 35bp hike in August, followed by 25bp rate hikes in each of October, December, February and April policies,” wrote Sonal Varma, chief economist for India and Asia ex-Japan at Nomura in a recent co-authored note with Aurodeep Nandi.

Analysts at Geojit Financial Services, too, expect the tussle between the bulls and bears to continue in the near-term, which is likely to keep the markets choppy. 

 

"A clear trend is unlikely to emerge in the market in the near-term. At lower levels domestic institutional investors (DIIs) and retail investors will buy, pushing the market up. At higher levels foreign portfolio investors (FPIs) will sell, pushing the market down. The dominant factor determining the market trend globally will be inflation, and how far central banks, particularly the US Fed, will go in hiking rates to contain inflation," said V K Vijayakumar, chief investment strategist at Geojit Financial Services.

Investors, Vijayakumar suggests, can follow a cautious investment strategy in this uncertain context and buy high quality stocks which will benefit from growth recovery. Leading financials, information technology (IT), cement, telecom and segments of autos appear sound investment bets, according to him.