During the first quarter of 2023, the market participants were sceptical due to weakness in the global environment, rate hikes across most economies, and the banking crisis in the US & Europe. However, later as commodity prices cooled down, inflation slowed, earnings grew healthily, and the RBI paused the rate hikes markets gradually peaked to newer heights.
The Indian economy is at a long-term secular mega-trend where the relationship with the historical is being muddled with distinct secular drivers creating inflexions that are of greater prominence for the current investment landscape. The risks to the macro are skewed towards the global slowdown, and geopolitical mayhem that seed intermittent periods of volatility in the Indian equities market.
In India, households have a lower level of exposure to equities in comparison to other types of assets. The sustained interest of domestic investors in equities points towards a prolonged trend. Domestic markets were resilient compared to weakness witnessed in global markets in the recent past due to uncertainties in the global environment indicating that dependence on FPI flows has been reduced.
India’s per capita income has crossed the crucial threshold level of 2000$ which is a milestone for a growing portion of discretionary expenditure. Additionally, we expect there to be a substantial increase in market size for luxury consumption in the future as we are observing a substantial increase in the number of HNI & UHNI’s.
India’s G-Secs are to be incorporated in three of its bond indices consisting of similar instruments issued by the governments of emerging markets. Starting from 1%, the allocation would rise to a maximum of 10% by March 2025. As the index is followed by global bond fund managers, it is estimated that funds of $40-45 billion could flow into India. Incremental allocation would also lead to a decrease in yields which will bring down the cost of borrowing for the government and also indirectly lower the cost of borrowing for companies. Further higher inflows will likely have a positive impact on the domestic currency relative to others. The process of internationalizing the Indian Rupee and reforming India’s capital market may pave the way for the eventual inclusion of INR in the IMF’s SDR. This development could have a positive impact on India’s Balance of Payments, and these favourable effects are expected to spill over into the equity markets.
We believe that political continuity is the most likely outcome in the upcoming national elections, though the margin of victory is likely to be slimmer. If such is the case, then the key thesis of a capex, infra focus and housing upcycle will likely continue to drive higher GDP growth.
The foundation for our optimism lies in the narrative that India is advancing, globally, positioning itself as the fastest-growing major economy. GDP growth during the first half of FY24 has been robust, exceeding expectations. Earnings in H1FY24 have been healthy. Additionally, we have observed that the proportion of profits in GDP has experienced an upward trajectory, ascending to nearly 5% at present, and is projected to go further up over the next three years. We anticipate robust annual earnings growth over the next three years, driven by a multi-decadal growth outlook for the economy, healthier corporate balance sheets, an expanding capex trend focused around infra, a multiyear credit cycle for financials, a structural increasing trend in discretionary consumption and a dependable reservoir of domestic capital.
We expect earnings to continue growing strongly in FY25 driven by a diverse spectrum of opportunities spanning various sectors driven by favourable factors that will benefit the Large, Mid and Small caps. We believe the markets are at reasonable valuations from the perspective of FY25 earnings and the rate cuts will benefit the markets disproportionately in terms of m-caps. Rate cuts globally will lead to inflows from FIIs.
Though our inclination is towards the mid and small cap, we expect the large caps to also contribute going forward as multiples expand for the market against the backdrop assuming a stable global macro, domestic political continuation, gradual rate cuts by the RBI and increased inflows from FII’s.
Authors: Prabhat Ranjan, Co-Fund Manager, Right Horizons, PMS, and Vijay Chauhan, Co-Fund Manager, Right Horizons, PMS
