It May Be A Good Time To Pull Back From Indian Equities, Says Deutsche Bank

The party may soon be over for Indian equities, warns a research report put out by Deutsche Bank. One of India's benchmark indices, the S&P BSE Sensex is just 3.5 percent from its all-time high of 30,024.74, gaining 8.8 percent so far in the first two months of 2017, on the back of surging domestic fund flows and a pick up in foreign institutional investments, post the Union Budget which was tabled on February 1. But the brokerage house in its report warns that this “liquidity-driven” expansion in valuations is unlikely to sustain much longer, and it might be “time for a pullback.”

The recent rally has made India the second-best-performing market, after the Hang Seng index in Asia this year. And at 28,984, the closing price as on March 1, the Sensex index is trading at 16.85 times its earnings forecast by Bloomberg for calendar year 2018, making it one of the most expensive emerging market indices, at the moment.

“With no material change in earnings estimates and no visible evidence suggesting the risk of consensus earnings downgrades – seen over the past three consecutive years - is now firmly behind us, the liquidity driven expansion in valuations looks unlikely to sustain,” the bank said in its markets research report titled Lights turning amber, time for pullback.

As much as 55 percent of Deutsche Bank's coverage universe is currently trading either at or above the five-year average valuations. Its the private banks, select non-banking financial companies (NBFCs), cement and consumer staples that look to be the most expensive, according to the brokerage house's calculations.

The financial sector is the “biggest underweight” in the model portfolio, as Deutsche Bank sees near-term headwinds for Indian financial institutions.

Muted loan growth is expected to continue to weigh in on net interest margins (NIMs), while treasury gains – a key source of earnings for financial institutions – is also at risk after bond yields spiked by 45-50 basis points, post the Reserve Bank of India's (RBI) last monetary policy, says the brokerage house.

Slow loan growth is likely to result in lower net interest margins (NIMs), while treasury gains – a key source of earnings – are also at risk after a 45-50-basis-point spike in bond yields post the Reserve Bank of India (RBI) monetary policy. Reliance on treasury has been high recently, even as banks have used it to make high provisions. Post demonetisation, the rush of deposits was used to buy government bonds which may also be out of money now.

Unlike the past, higher bond yields are not associated with better growth and improving NIMs. Even asset resolutions remain slow.

Also Read: M&A Optimism Leads Morgan Stanley To Raise Sensex Target To 33,000

On the other hand, its the pharmaceutical sector that's back in favour with Deutsche Bank which has raised it to the ‘overweight' category. The reason for this upgrade is the brokerage house's belief that the U.S. Food and Drug Administration (FDA) worries appear to be ‘overdone' and the below-average valuations make it a good time to invest in the sector.

“Pharmaceuticals appear to offer value with five out of eight companies under coverage trading sharply below the past five year average valuations,” the report added.

While the sector has seen a severe de-rating over past twelve months due to multiple headwinds, over the past three months, the larger drug manufacturing companies like Lupin Ltd., Cadila Healthcare Ltd., Aurobindo Pharma Ltd., Glenmark Pharmaceuticals Ltd. and Cipla Ltd. have received fewer observations and have successfully resolved their outstanding U.S. FDA issues. “We believe that Sun Pharmaceutical Industries Ltd.'s valuation de-rating appears excessive (stock trading at valuation which is 31 percent below past five year average) and worries overdone,” the report added.

According to the report, Bajaj Finance Ltd., Yes Bank Ltd., Whirlpool India Ltd., Bharat Forge Ltd. and Indraprastha Gas Ltd. stand out with valuations far above the mean. Sun Pharmaceuticals, Jubilant Foodworks Ltd., Cipla, ICICI Bank Ltd. and Wipro Ltd. on the other hand, trade at valuations below mean.