Our markets are a long-term value creator and every correction will be a great opportunity to enter with moderate return expectations.
Jan 1, 2025 07:30 IST First published on: Jan 1, 2025 at 07:30 IST
In the last five years, equity returns have been broad-based and exceptionally high, especially in small and mid-caps. Almost a four-fold jump in profits between 2020 and 2024 supported the broad-based rally. A lower base due to the below-par return in the preceding 10 years also helped generate higher returns. Loss-making sectors like PSU banks, telecom, and oil marketing companies that were turning profitable helped make the big jump. Local investors have used every opportunity, including heavy selling by FPIs — October 2021 to June 2022 and October to November 2024 — to increase their equity allocation. Regular supply from promoters and IPOs haven’t deterred their appetite. In such a strong flows-driven market, it is natural that there are some excesses. Some stocks with controlled/low-float are trading well above their fair value. Some stocks are valued at exceptional future performance or, as we call them, price to vision. Some IPOs have happened at a valuation higher than the valuation of existing listed companies. These are bull market excesses, which do get sorted out over time. While it is difficult to predict the future, it is rational to expect that the following five factors will need to be monitored in 2025.
Investor confidence: Domestic investors are confident about India’s growth story. Unlike in the past, it is backed by strong leadership at the country and corporate levels. India is likely to remain the fastest-growing major economy for some time, growing at mid-single digits. The capital allocation efficiency of India Inc. is expected to remain better than that of its peers, reflected in a higher return on equity/capital. Investors will be confident of double-digit growth if India implements next-generation reforms like more straightforward land acquisition, flexible labour laws, and the rule of law. India must aim to be richer before it gets older. Our window of opportunity is short. The world is changing from globalisation to protectionism. From Unipolar (US-centric) to Multi-polar (US and China). From excessive to adequate liquidity. From zero/low interest rates and low inflation to elevated rates and high inflation levels. From ignorance of environmental norms to awareness of environmental conditions. Unlike China, whose growth had tailwinds of globalisation, India will have to grow in the headwinds of globalisation. The disruption unleashed through technology can become our headwind or tailwind depending upon how we master it.
Return expectations: 2025 will likely be a year of significantly lower returns than the last five years. The range of returns will be narrower between large, mid- and small caps, with the risk-return ratio favouring large caps. Sector rotation and stock selection will be key as the market rally narrows and moves across sectors and stocks. Bruised bluechips, reasonably valued stocks/sectors like Pharma, IT, telecom, rural consumer staples and financial services are likely to outperform momentum stocks. Some stock pricing in exceptional future performance will likely face a reality check when the burden of profitable growth starts weighing on the fund flows. Keep an eye on insider activity, especially at these counters.
FPI flows: Since Covid, FPIs have been using the revolving door to enter/exit India. They are buyers one month and sellers another. Markets weaken when FPIs sell aggressively. FPIs are underweight in India. While they can justify the underweight based on valuation, it will be challenging to ignore the long-term growth potential. Many peers of India are scoring self-goals. Russia is out of bounds due to the Ukraine war. Brazil is losing favour due to communist policies. South Africa is in social turmoil. Under President Donald Trump’s administration, China and Taiwan will have high uncertainty. Other emerging markets like Argentina, Vietnam, Indonesia and Saudi Arabia, etc., are not large from an investor’s point of view. As long as our growth and governance are compelling to FPIs, they will likely be buyers at lower levels. Markets can spike up in case FPIs turn aggressive buyers as no one gives easy entry to an aggressive buyer. The Indian market is easy to exit but difficult to enter.
Regulatory measures: Our markets will react to regulatory measures. Any change in capital gains taxation, increase in equity allocation from pension, increase in divestment supply, fair implementation of ESG norms, etc., will impact our markets. Trump’s announcements will add its share of regulatory measures that the market will have to deal with. Undoubtedly, America First will be the cornerstone of their policy. The DXY has become stronger on expectations of such policies. India must convince the US that a partnership will create a win-win situation. The US has improved efficiency and created trillions of dollars of wealth through Indian IT talent. Whatever the US imports from China, they will be worried about sabotage and bugging. Despite millions of lines of coding and programming imported from India, they don’t have to worry about any cyber risk/security breach. The India-US partnership can materially improve security, efficiency and cost for the US while creating jobs and growth in India. Realisation by the US and shift from China to India will benefit our economy and market.
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Valuation: India Inc. will have to carry the burden of expectations as reflected in our premium valuation, by delivering better earnings growth and corporate governance. Despite subdued growth in the second quarter of 2024-25, earnings expectations for the full year are likely to be met. Considering slowing global and domestic growth, 2025-26 earnings expectations will have to go down from high to low teens. As long as investors feel that any disappointment in earnings is a short-term deferment, valuations can be sustained.
Our markets are a long-term value creator and every correction will be a great opportunity to enter with moderate return expectations.
The writer is MD, Kotak Mahindra AMC
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