The outcome of the general elections 2024 is considerably different from what the exit polls predicted. The disappointment of the equity markets is reflected in the sharp downturn of the indices.
Indian markets have been trading at a premium to other emerging markets, given relatively higher growth as well as a premium given for political and policy stability.
From here on, there are a few variables that are likely to shape the markets. In the near term, these would include the details regarding the formation of the government and analysis of the election verdict by political parties. In the medium term, the focus would be on the direction of policy initiatives, the vision outlined by the new government, the trajectory of economic growth, corporate earnings and flows. It is likely that support for consumption at the bottom of the pyramid will be considered to create inclusive growth. The markets will take time to analyse these developments. Slowly, we do expect that the markets would go back to fundamentals after the initial reaction wears off.
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The global backdrop is also changing rapidly. The world is moving from globalisation to protectionism. Interest rates are likely to remain elevated and fiscal stimulation will continue to recede. Environmental considerations, along with technological disruptions, will likely impact many businesses.
As far as India is concerned, the trinity of factors that have been driving equity markets so far, viz, (1) macro-economic conditions, (2) robust corporate profitability, and (3) domestic flows, remains resilient. The recent data show real GDP growth stood at 8.2% in FY24 (against the advance estimates of 7.6%). This growth was on the back of a robust ~7% growth reported in FY23 and it makes India rank among the fastest-growing large economies of the world. Inflation is at ~5% and the twin deficits (current account and fiscal) are largely stable. Oil prices have been range-bound.
While India is not an island, the stable external position could help limit any external shocks to India in case the global cycle turns adverse. While the growth outlook remains solid, one cannot ignore market valuations. On the one hand, Indian markets have been trading at a relative premium to other emerging markets, given political stability and growth outlook. On the other hand, FY24 corporate earnings were ahead of expectations like the GDP growth outcomes.
The Nifty ended FY24 with ~24% EPS growth and the expectations are of mid-teens earnings growth for FY25/26 (consensus). Hence, while the market cap is at an all-time high, the profit-to-GDP ratio has also trended much higher in the last 4 years. Further, the corporate sector and banking sector balance sheets are in the best of health. In terms of market cap segments, the percentage market cap shares of mid and small caps are at all-time highs, while large caps near their previous lows. Hence, large-caps continue to remain better placed from a risk-reward perspective, while mid and small caps are trading at multiples much higher than their long-terms average. Delivery of earnings becomes even more critical, especially for mid- and small-caps. We continue to prefer large caps and large midcaps over small and micro caps. We would look at buying high quality companies available at reasonable valuations compared with chasing momentum. We would also continue to avoid stocks with low floating stock which are trading at higher valuations compared to what is justified by fundamentals.
Post an event such as this, one would have to wait and watch on the path taken in terms of policies adopted by the new government. For Indian markets, with fundamentals in place and if domestic flows remain strong, the markets can look to bottom out once there is clarity on government formation. Foreign investors have booked profits, but will likely be buyers at lower levels and cheaper valuations. In terms of sectors, the de-rating cycle of FMCG and large private sector banks seems to have bottomed out. Election spending and good monsoon can support consumption. We would also keep a close watch on sectors such as large-cap technology stock and chemicals, wherein valuations have corrected significantly.
Any event not turning out as per the market’s expectations will have its impact. However, over time, markets are slaves of earnings growth and profitability. If economic stability, GDP growth and the earnings trajectory remains intact, this short-term election-related volatility will also likely come down, providing an opportunity for long-term investment.
Nilesh Shah, managing director, Kotak Mahindra AMC
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