Q2 results expected to be muted; Indian stock market may see more downgrades

The stronger impact on domestic stock market is partly because we were playing on a weak wicket. In the weeks prior, the domestic market had been underperforming relative to other EMs. The underperformance intensified as investors began shifting funds to Asian counterparts like China, which are trading at significantly lower valuations—10x to 25x forward P/E in dollar terms, compared to India's premium valuation. India was trading at premium valuation for a long time due to the economic supremacy. But recent corporate earnings growth has stabilised with a negative slope, indicating that India will have to bear a correction in valuation.

Rising tensions in West Asia have caused a disproportionate impact on the Indian stock market compared to global clampdown. Since 26th Sept, Nifty 50 is down by 4.5%, while major global indices have fallen by just 1.25%, excluding China which is up by more than 10%. World is coping better while given India's dependence on crude oil imports, the surge in oil prices has a direct effect on its trade deficit. With crude prices up by 10%, the resulting volatility is affecting both the currency and stock markets.

We maintain our view that India is likely to underperform other EMs in the short term, with midcap stocks expected to lag behind domestic large caps. This shift in our outlook was already in motion before the recent Israel-Iran conflict, which has only intensified the situation. The heightened tension is expected to hold the uncertainty elevated as the world awaits to see the response of Israel to the Iran missile attack. The broader concern—or hope—is that this historic skirmish does not escalate into a full-scale war, with the U.S. playing a pivotal role in the background.

The Ukraine-Russia war had profound economic consequences, severely disrupting global supply chains. Ukraine, a vital supplier of key food commodities like corn, wheat, and edible oil to regions including China, faced major export challenges. Simultaneously, Russia, a key supplier of oil, gas, and metals to Europe, saw its commodity flows impacted. The war happened at a time (Feb 2022) when the world was already burning under the COVID-19 led low-capacity utilisation affecting supplies and leading to hyper world inflation.

The economic trade of both Israel and Iran with the global market is largely limited, as it lacks essential goods, which minimizes their direct impact on global inflation. But Iran is the 9th largest oil producer in the world, and the collision is happening near key shipping lanes and the oil trade region, which is already spiking crude prices. This is expected to be negative for India, escalating the risk of underperformance.

Q2 earnings to start next week

Another key area of focus in India will be the start of corporate Q2 results this week. It will start with the IT sector, which is expected to see a marginal improvement in earnings growth on a QoQ basis. Whether they are good enough on a YoY basis to suggest the current decent high valuation is another point. The push is from data centres, North America, the healthcare sector, and ERP. While sector margins are likely to remain mixed due to deferred wage hikes and budget constraints among clients, leading to cuts in discretionary spending. Clients continue with their budget squeezes and cuts in discretionary spending. Despite these challenges, there are signs of a gradual recovery in client spending, particularly in modernization and discretionary areas. Outlook is likely to improve for BFSI as the US Fed is expected to cut rates to a good degree going ahead. In the near-term IT sector is likely to continue its growth trajectory, albeit at a slower pace. The sector has performed well in the last 3yrs, taking the valuation to 3yr high, which will affect performance in the short-term. Domestically, there is a traction in the sector’s investment given its defensive nature which is expected to continue.

Banks, a key sector to start the session, has a subdued view. Lower-than-anticipated budgeted spending by the Central Government and subdued growth in advances and deposits are expected to continue exerting margin pressures in the second quarter. Industry advances are expected to grow by only 4.05% QoQ, significantly lower than the 8% QoQ growth achieved last year. Consequently, only marginal improvements in bank profits are anticipated. Furthermore, stress in the SME segment could lead to increased delinquencies, resulting in higher-than-anticipated provisioning, which would further hinder bank profitability.

The beginning of the Q2 earnings season is expected to start on a mixed trend, with a negative prejudice. There is a risk of short achievements in the coming 1-2 quarters. This may lead to downgrades as the market continues to hold the view that earnings growth will revert. Q1 was weak due to the national election effect. There is a prevailing market sentiment that steady domestic demand, shift in global demand and lower inflation compared to last year will support earnings growth in the future. This view will be tested in Q2.

The author Vinod Nair, is the Head of Research, Geojit Financial Services.

Disclaimer: The views and recommendations provided in this analysis are those of individual analysts or broking companies, not Mint. We strongly advise investors to consult with certified experts before making any investment decisions, as market conditions can change rapidly and individual circumstances may vary.