Post the Annual Budget announcement on Thursday, 1st Feb, Indian markets corrected by ~2.3% on Friday, 2nd Feb partly attributed to the proposed LTCG tax. Central Board of Direct Taxes issued clarifications in the form of FAQ, to quell any confusion and help soothe nerves. However, the already nervous sentiment was further hit by a global equity rout on Monday, as US stocks suffered their worst fall in more than six years amid heightened concerns of higher inflation and rising bond yields. The S&P 500 fell 4.1%. In Europe, the Stoxx 600 fell 1.7%.
The US market sell off appears to have been triggered by the latest higher than expected wage growth report. Citi notes that higher wage growth helps support consumption and growth and has historically led to higher earnings growth. While Citi analyst’s believes that wages and inflation have bottomed in the US, they expect upward inflationary pressures to be contained. Citi’s forecast for US inflation is 1.9% for 2018, up from 1.7% in 2017.
While global markets may remain volatile in the near term, Citi analysts feel more comfortable putting new money to work now, given higher yields and volatility across developed markets. Apart from lower investor complacency, the fundamentals have not changed.
Back home in India, valuations for benchmark indices have been trading well above 1sd over mean for some time now. The Quarter 3 earnings season is underway and aggregate reported earnings are off to a good start, with 56 out of 100 BSE-100 companies reporting a ~21% YoY jump in earnings vs 13% YoY expected thus far.
Earnings trends (56/100 BSE-100 companies)
Source: Citi Research
Citi analysts believe that earnings recovery would be a key variable for any upside in equity markets from these levels. They further note that flows (both local & FII) remain a big driver of markets and the impact of LTCG tax proposal on the domestic flows needs to be watched further.