Flat returns in near term is the best investors can hope for, says Sanjeev Prasad of Kotak Equities

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After two calendar years of double-digit returns, flat-to-modest gains in the domestic equity market in the coming few months will be a good outcome for investors, Sanjeev Prasad, managing director and co-head of institutional equities at Kotak Institutional Equities, said on February 16.

Indian equities have been flat so far in 2022, as investors juggle rising concerns of aggressive rate hikes by the US Federal Reserve, geopolitical risks in Eastern Europe and expensive valuations.

“A bad outcome could be 10-15 percent price correction on negative global geopolitical developments, which could result in a sharp spike in crude oil prices with its negative implications for India’s BoP, growth and inflation and a further increase in domestic bond yields on higher-than-expected inflation,” Prasad said in a note.

Bond yields have risen 33 basis points in the past two and a half months on concerns over stubbornly high inflation and the government’s large borrowing programme.

As per Kotak Equities, the risk-reward for investors in the Indian equity market has deteriorated in the face of rising government bond yields and increasing concerns on the macro-economic front led by a surge in crude prices.

Kotak Equities noted that equity valuations still remain expensive across sectors and stocks despite a more than 7 percent correction in the Nifty from its record high in October 2021.

“Earnings have only seen modest upgrades and that, too, on the back of earnings upgrades to the upstream oil and gas sector on higher oil and gas prices. There is little comfort for the market from either valuations or earnings,” Prasad said.

The Nifty is quoting a price-to-earnings multiple of above 20 times one-year forward earnings, which is still 1.5 standard deviations higher than its long-term average.

“The market’s valuations already price in our assumptions of strong earnings growth over FY2022-23,” Prasad said.

Kotak Equities expects the Nifty’s net profits to grow by 36 percent in the current financial year and 19 percent in the next.

Prasad is concerned about the widening negative gap between bond yields and earnings yields also known as the BEER ratio.

The BEER ratio is a measure used by investors to gain a sense of the attractiveness of equities when compared to a risk-free asset like government bonds.

While the gap between bond yields and earnings yields in India has been negative for over a decade, it is currently “uncomfortably high versus historical levels, especially as we expect bond yields to increase further from current levels and see continued challenges to India’s macro-economic outlook”, Prasad said.

“The market may require earnings upgrades to perform. However, we rule out the same for most sectors and stocks as we already build in strong earnings growth over FY2022-23,” he said.

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