Crude above $100: The danger zone for Indian stocks and why the next 2 weeks are critical

Edited excerpts from a chat on market outlook and opportunities:

Crude oil prices have been hovering above $100 a barrel mark. At what level, do you think the India equity story starts becoming meaningfully uncomfortable for investors?
For an oil importer like India, the impact of high oil prices can turn out to be very adverse if the prices remain elevated for an extended period. A 10% increase in crude (estimated roughly at $10) causes about 20 bp reduction in GDP growth, 30 bp increase in CPI inflation and 30 to 40 bp increase in current account deficit.This adverse macro impact will manifest if the crude price remains elevated for long. In the ongoing crisis, the durability of the crisis is significant. If the war ends soon (it can end any time) or if there is significant de-escalation and opening of the Hormuz Strait, crude can immediately fall to $80 level. In such a scenario, the adverse impact will not manifest. Another two weeks of crude above $100 is a temporary shock which the Indian economy can absorb. But beyond that, the economy and markets will be impacted.

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Do you think the market is still underpricing the second-order effects of war, especially on inflation expectations, bond yields, and consumer sentiment?
The market is even now discounting a quick end to the war and cooling of oil prices. The market is not discounting a prolonged war and elevated crude oil price for long. Contrary to market expectations, if the conflict escalates and crude rises above $120 and remains at that level for many weeks, the market will further correct from the present levels. Everything boils down to how long the conflict continues, more importantly, how long Hormuz Strait remains restrictive.

How vulnerable is Q4 earnings season to this backdrop? Which sectors do you expect to show the sharpest earnings impact in Q4 from elevated crude and freight costs?
Q4 is unlikely to impact earnings significantly. The impact will be felt in Q1 FY27. However, the war and the consequent uncertainty will show up in some segments. Industries using petroleum inputs like paints, adhesives, and tyres will be hit. Manufacturers using LNG as fuel like verified tiles have been hit hard. Exporters will gain from currency tailwinds. IT will gain; but the Anthropic shock will continue to weigh on the segment. Exporters to the Gulf region will be impacted marginally.

Do you expect another round of earnings downgrades over the next few weeks if oil stays elevated?
If crude remains elevated and gas availability restrictions continue, another round of earnings downgrade will become inevitable. Earnings downgrades will be in import intensive and crude related segments mentioned earlier.

Has the small cap correction created genuine value, or are pockets of the segment still frothy despite the damage?
Correction in small caps has opened value in many segments. Broadly small cap valuations continue to be high, but there are segments with attractive valuations and high growth prospects. These are across industries and, therefore, stock selection holds the key to successful investment. An ideal strategy would be to invest in small cap mutual funds.

How are you thinking about banks in this setup, especially if higher inflation complicates the rate outlook?
Banking is one segment that is attractively valued now. Sustained selling by FPIs in leading large private sector banks has made the valuations in the segment attractive. This segment is an excellent long-term buy for investors. Credit growth in the economy continues to be good. The MPC is unlikely to increase the interest rates soon since inflation arising from supply shocks cannot be addressed through rate hikes.

Help us understand why PSU bank stocks have been the worst hit and whether one should be brave enough to buy the dip as the growth story looks promising but yields are playing spoilsport?
PSU bank stocks had a good run recently. What we are witnessing now is profit booking in the segment. This segment can be considered selectively for investment.

If the market was to rebound from here, which sectors do you think will lead the rally?
In the event of a sharp bounce back in the market, all beaten down but fundamentally strong stocks will rally smartly. But if FPIs continue to sell the rally, large cap banking names may continue to disappoint despite the strong fundamentals and attractive valuations. IT appears set for a tactical bounce back in April since the Q4 results are unlikely to disappoint. Automobiles and auto ancillaries are on a strong wicket. Telecom will remain resilient. Pharmaceuticals have potential to appreciate.