The recent recovery in Indian equities could have further room to run, but the next leg of the rally will depend on how geopolitical developments, crude oil prices and corporate earnings unfold. A decline in crude prices could ease cost pressures on companies, support margins and trigger an earnings upgrade cycle, providing a further boost to the market.
Nikhil Ranka, CIO of Equity Alternatives at Nuvama Asset Management, believes the market recovery has been driven by expectations of easing geopolitical tensions and improving crude oil supply through the Strait of Hormuz. He sees the possibility of crude oil prices falling towards $75 a barrel, which could provide an additional boost to equities.
Speaking to CNBC-TV18, Ranka said the Nifty could move towards 25,800-26,000 in the coming months if geopolitical tensions ease and the index manages to cross a key resistance level of 25,200.
But what needs to happen for the market to sustain its recovery? And which sectors could benefit if crude prices decline?
What is driving the market recovery?
Ranka attributes the recent market bounce to two developments: expectations of a reduction in geopolitical uncertainty and the improvement in crude oil movement through the Strait of Hormuz.
He pointed to the political developments in Israel and the US, including Donald Trump losing both houses, as factors that could help ease the geopolitical uncertainty seen over the past 18-24 months.
The other important indicator is crude oil traffic through the Strait of Hormuz. According to Ranka, traffic has recovered to more than 90% of pre-war levels. He believes this could help reduce the geopolitical risk premium currently embedded in crude prices.
Ranka estimates that crude oil still carries a risk premium of around $15-20 a barrel. If this premium unwinds and prices move towards $75, Indian companies could benefit from lower input costs.
This is important because several companies reported healthy revenue growth in the September quarter but faced pressure on margins. Higher input costs and inflation prevented them from passing on the entire cost increase to customers.
Despite these pressures, Nifty companies delivered earnings growth of close to 20% in Q2. Ranka believes a decline in crude prices could provide further relief to corporate margins and trigger earnings upgrades. This, in turn, could help the market return to 20 times one-year forward earnings.
Nifty outlook: What are the levels to watch?
The recent rally has been partly driven by short covering, particularly in stocks that had fallen to their 52-week lows. However, Ranka believes there has also been a reduction in leverage among high-net-worth individuals (HNIs), which could help improve market stability.
He said the leverage-related figure had declined from a peak of around 2,15,000 to approximately 1,90,000, indicating that a significant amount of leverage had been reduced.
Another factor is that several investors whose positions were liquidated during the market decline have missed the sharp recovery. Ranka expects some of them to return to individual stocks once the market consolidates.
He sees a consolidation phase between 25,200 and 25,500 for three to four days as important for restoring investor participation.
On the downside, Ranka believes 24,500 is beginning to emerge as a base for the Indian market. On the upside, a sustained move above 25,200, supported by some settlement in the West Asia crisis, could pave the way for the Nifty to reach 25,800-26,000 in the coming months.
24,500 clearly seems to be starting to look like a base for the Indian markets.NIKHIL RANKA, CIO OF EQUITY ALTERNATIVES, NUVAMA ASSET MANAGEMENT
Why could FMCG stocks see a recovery?
FMCG and staples companies could benefit from a combination of lower input costs and the price increases already taken in recent quarters.
Ranka highlighted the margin pressure faced by staples companies in the September quarter. One of the largest companies in the sector, for instance, saw its margins contract by nearly 300 basis points quarter-on-quarter.
Several companies have taken price increases in Q2, and Ranka expects the benefits of these hikes to become more visible in the December quarter. If input costs also moderate, companies could see an improvement in gross margins.
The opportunity is significant because staples companies have struggled with subdued earnings growth over an extended period. According to Ranka, most companies in the sector have delivered single-digit earnings growth over the past 24 months, resulting in a sharp correction in their valuation multiples.
He estimates that valuations are now almost two standard deviations below their historical levels. A return to double-digit earnings growth could therefore support both earnings upgrades and a re-rating of valuation multiples.
This makes staples a potential beneficiary of an improvement in the cost environment, particularly after a prolonged period of underperformance.
Why are aviation and OMC stocks on the radar?
Oil marketing companies (OMCs) and aviation are two other sectors that Ranka believes could see a catch-up if crude oil prices decline.
For aviation companies, the opportunity comes from the pricing strength they have demonstrated despite elevated costs. Ranka said airlines have managed to increase yields by 25-30% without a significant decline in load factors.
If crude prices cool, airlines could retain the benefits of these higher yields while also seeing an improvement in load factors. This could provide further support to the sector.
OMCs are also among the sectors Ranka identified as potential tactical plays in an environment of easing crude prices.
Why could capital market stocks benefit after December 7?
Apart from sectors that could benefit from lower crude prices, Ranka sees opportunities in capital market stocks as activity in the derivatives segment begins to recover.
He expects expiries to return to their normal schedule from December 7, which could support a revival in the options market.
There are already signs of improving activity. Ranka noted that implied volatility has increased from levels of 10-11 to 17-18, indicating renewed traction in the options segment.
He believes capital market stocks could perform well after December 7 as activity in the derivatives market picks up.
For the broader market, the key trigger remains the trajectory of crude oil prices. A decline towards $75 could ease corporate cost pressures and support earnings, while improving market positioning and a revival in investor participation could help sustain the rally. If these factors come together, the Nifty could have room to move towards 26,000 in the coming months.
Can Nifty hit 26,000? Nuvama’s Nikhil Ranka explains what could drive the next rally