CY23 turned out to be a year of stellar returns with Nifty delivering a return of 20.0% and Mid cap and SmallCap delivering close to 50%.  So where do we go from here? We highlight some of the key themes that will play out over the year. 

#1: Politics will occupy centre-stage

  • CY24 is a heavy political calendar with elections in 40 countries spanning over 40% of the world population. The market will be focused mostly on the Indian elections obviously followed by the US elections.
  • On the margin, we believe elections and politics probably occupy more attention and mind space of equity market investors than it deserves. Our analysis is that there is no meaningful difference in the stock market performance or GDP growth in regimes headed either by the Congress or the BJP.
  • However, the reason for the election focus is that they have the tendency to create huge moves (both positive and negative) on the election result date. Generally, the market prefers continuity of the Government and any adverse outcome from this expectation can create huge negative correction.
  • Most opinion polls show a convincing win for the Modi-led NDA Government, especially after the strong showing in the assembly elections. 
  • Based on election analysis, we have highlighted a few important points for markets:
  1. The run up to elections has generally been good for equity markets. Buying 6 months before elections and selling on the day before counting of results has mostly given a positive return. 
  2. The day of counting leads to very volatile markets depending on the Government market perceives as reform friendly. So, the Vajpayee Government loss in 2004 (and UPA-1 came to power) led to a major negative day but when the same UPA got re-elected in 2009, markets rejoiced.
  3. Yet, the first day reaction of the market to any Government does not reflect how the equity markets will react to the Government a year later. 
  4. Generally markets are positive 6 months and 12 months post elections as the market focus shifts to more fundamental issues.

#2: Inflation has peaked – Fed will cut rates; RBI will follow in H2CY24

  • The Fed has signaled that inflation has peaked and they are ready to cut rates. However, the bond market has started pricing in close to 150 bps rate cuts this year which does not square up with a soft landing scenario. Equity markets may be disappointed if the soft landing scenario comes into question or the rate cuts are slower than currently expected.
  • Can inflation rise sharply? We think it is unlikely except with the war in the Middle East intensifies raising (a) oil prices (b) freight rates as insurance costs rise and ships take a longer route than the Suez Canal.
  • India will similarly benefit from falling inflation and we see RBI cutting rates by 50 bps in H2CY24.
  • Finally, a last question here is whether rate cuts are good for the markets? Markets do well after a pause in the Fed rates which we have already seen. But post the first cut by Fed, the market returns have been mixed. 

#3: How will USA economy do? Are earnings slowing in India? 

  • Consensus expected a recession in the USA in CY23 but the growth remained strong. Most of the economists no longer expect a recession in CY24. We see growth slowing given the way M2 has fallen.
  • While a weakness in the global economies will hurt the Indian economy too, we think India will still see GDP growth of around 7%, probably the fastest in the world and the structural story is unlikely to be impacted.
  • However, earnings are likely to go on a slower track. After growing at 30% in H1FY24, we see earnings growing at only ~8-10% in the second half as base impact of the banks catch up.
  • Overall, however, we still see earnings doubling in 5 years. 

#4: Is too much good news in the price short term?

  • While we continue to remain excited by the long-term India story, we think a correction in the markets would be healthy and create a margin of safety. 
  • Absolute valuations at 20x 1-year fwd are expensive and historically returns have been low by investing at these levels. A time and price correction could reduce the over-valuation.
  • In a relative context too, India trades at near 100% premium to EM valuations, way above historic averages.  A correction in relative valuations would provide room for increased FII flows into India.
  • Retail investors have provided strong support to markets. However, investors since Covid have profited by buying every dip. Any prolonged time and price correction will test the durability of these flows.