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MOSL: INDIA STRATEGY-Volatility returns, but earnings story improving-Highlighting our preferred ideas in this correction

India Strategy: Volatility returns, but earnings story improving; Highlighting our preferred ideas in this correction

 

Volatility returns after a relatively smooth CY17

The Indian equities markets have witnessed a severe correction, with the Nifty Mid-cap100 index declining ~10% and the benchmark Nifty sliding ~5% over the past month. The sharp volatility – the VIX index up 27% since 31^st January 2018 – over the past few weeks can be ascribed to unsupportive global developments as well as domestic policy events (especially the Union Budget). What’s more disappointing is that the gloom comes after a smooth upward ride in CY17, when the markets did not once witness a drawdown of even 5%.

Bond yields hardening; valuation multiples moderating

Hardening of bond yields globally is one of the key factors driving the market correction. Bond yields in India have hardened from 6.3% in July 2017 to 7.6% now. We had pointed out in our recent note that post the rise in bond yields, the markets (especially midcaps) were looking expensive on our P/B versus excess RoE framework and needing earnings support in the absence of cushion from lower cost of capital. Midcaps are trading at a premium of 40% to large-caps – an all-time high. The recent correction, however, has moderated this premium. We highlight the narrowing gap between earnings and bond yields in both developed markets (the US) and India, and the necessity of earnings pick-up to maintain current valuations.