Not A Smooth Runway For Equities

There are some potential landmines for the Indian equity markets in the next 12-18 months. Some emphasise that the state election results, which may swing the mood either side, to the big 2024 showdown is arguably the biggest piece in town. But aside from politics, the uncertainty around interest rates, growth in a slowing world, valuations and flows continue to be the biggest factors for equity sentiment and performance. One could argue that most of these factors were known to the markets even when they were slightly more buoyant, and therefore, it is difficult to fathom what was the last straw on the camel's back. My bet is the inflation data and the resetting of rate expectations is the reason behind the sombre equity sentiment currently prevalent.

Globally, it seems that reality is now hitting home for stocks. The final nail on the coffin might have been the 0.7% monthly jump in producer prices in the U.S. and hawkish Fed comments. With all this, it may be the case that the flurry of data finally became too much for markets to ignore. The bond markets globally had priced in further rate hikes following the January jobs report, hotter-than-expected inflation figures, and strong retail sales. But the equity market had been shrugging off strong economic data, maybe getting comfortable with a thought that inflation, though higher than anticipated, was under control. The data came and said it wasn't so. Core inflation for the U.S. and India is high and stubbornly sticky. And therefore, there's a very high possibility that the U.S. Fed and the RBI will remain hawkish and raise rates more than earlier expected.

The data points last week promptly led to a reaction in India as well, where we saw 10-year yields rise to 7.45%, the highest since November 2022, leading to the Nifty slipping below its 200-DMA for the first time since September 2022. There was also chatter around the spike in yields now leading to an impact on multiple fronts, including the government borrowings in FY24 facing hiccups. Experts tell me though that borrowing should mostly be smooth, even if not as smooth as last year—as insurance inflows may be lower/state borrowings would be higher—but will go through. And if the RBI becomes more neutral, it can support if need be.

On balance though, this is a tough set-up for duration risk for EM equities and currencies where the U.S. recession is not as much of a problem as the lack of it is. As a very senior investor said the what if U.S. doesn't enter a recession and yet inflation cools off to 2%; the next year and a half is going to be a nightmare for risk takers as they will be forced to revisit their thesis of the post Global Financial Crisis 'new normal' regime. Maybe, there wasn't a new normal regime. And that scenario may continue to be an overhang for risk assets.

Other factors are not helping either. Earnings growth has not exactly been heart-warming in India, which is touted by almost everyone to be the oasis of growth. The third quarter of FY23 saw headline PAT growth of 6% for NSE 500 companies. 81 BFSI companies led the show with 48% PAT growth and 415 non-BFSI companies saw an 11.8% decline. A Motilal Oswal note sums up the performance, where their universe of companies showed a wobbly performance, with the ex-Nifty universe of 173 companies was 15% below estimates.

It must be pointed out though, that among the larger markets, growth in Indian stocks would still be the best. And valuations are now no longer as uncomfortable as they were a few months ago. There has been a large outflow of money from India in the last few months as well, and therefore the base of selling has changed considerably. One now hopes that we don't face an El Nino element and a subsequent drought-like situation, because like Emkay Global noted, all instances of drought in India over the last 20 years have been in El Nino years. In a year before the election, where the the government has nicely resorted to a non-freebie model in the union budget, we need the rural economy to be in good shape for the government to be able to implement its vision of capex and, thereby, the expected job creation. It was the shining piece in the budget, and one should hope that externalities do not rob the government from its full implementation. That would be a negative for equities over the medium term.

Niraj Shah is Executive Editor at BQ Prime.