Dear Investor
In this edition of market outlook, let us discuss the following:
- Q2 result season aggregates and expectations for the next period
- Last period was eventful from market impact point of view
- Flows: FPI sales have continued to be strong
- Valuations
- It continues to be time for alpha
Q2 result season and expectations for the next period
Q2 result season was overall weak. However, most large misses were in the commodity pack. This quarter was expected to be weak because of strong monsoon intensity. For example, if on account of rains, the weather is cooler, less of air-conditioning would be used resulting in lower power demand and hence generation. Similarly, higher rains in the open cast mining areas would hamper activity resulting in lower mining.
Our choice of companies had a good result season overall. Most companies beat expectations.
We believe the next period may see the benefit of strong monsoons in better purchasing power in Rural India and may see the benefit of re-start of government spending. Hence the outlook for the next half is better.
Last period was eventful from market impact point of view
The month of October had several events which took place one after the other:
• Chinese stimulus package and the flow of money into the Chinese market from other Emerging Markets. However, the market performance and stimulus induced inflows seem to have run its course. The stimulus is seen as below expectations and some foreign brokerages have already brought out reports on the same.
• Increase in US bond yields that reversed the inflows received in Sep as bond yields had fallen
• Trump emerging victorious in the elections. He has promised to make America Great Again. The proposed routes and its implications are as under:
- Increased focus on manufacturing: This would involve protection against China. He has spoken of higher than current import tariff barriers. After China, Mexico is the next biggest source of trade deficit for the US. There already is speculation that Chinese are re-routing their exports through Mexico. Trump has talked about 25% import duty on Mexican imports. India has a surplus but a small one and would mostly be taxed lower. This would be advantageous to Indian manufacturing.
- Reduced taxation on the rich and corporates: This could help corporate profits immediately and increase the scope for extra spending, for example on tech services. However, this implies that fiscal would be stressed. Higher import duties would help address some of this stress as it would be paid by US consumers. American economy is nearly at full employment economy and substitution of imports with American production would largely not occur except in strategically important industries.
- Higher duties would be inflationary and imply higher bond yields. This could lower the chances of continued FED rate cuts making USD stronger and thus increasing the flow of money back into the US.
- Global peace and Defense: Trump also wants to achieve peace between Russia and Ukraine and is backing Israel strongly. While peace is welcome, it would probably come at the cost of a loss of around 20% of Ukraine territory. This could continue to keep military spending high for the near future. A resolution may work in favour of Indian defence companies as they start getting components from America (engines for Tejas) and Israel and Russia. Also, Trump wants Europe and rest of the world to shoulder a larger part of overall defence spend and not depend on implicit US protection guarantee.
- Trump wants to tweak Inflation Reduction Act (IRA): While the IRA is often thought to be an act for/supporting green energy, its aim is broader & more sweeping. It aims to reduce the federal government budget deficit, lower prescription drug prices and invest in domestic energy production, while promoting clean energy. Moreover, IRA is the last of a series of measures taken to promote renewables.
- Southern Sunny states, aligned with renewables, are where Trump has done well. Solar here is already competitive vs other sources of energy and there are plans to scale it up rapidly
- Elon Musk thinks that most power in future would be solar driven
- Overall impact is as under:
- US equity markets look much more attractive as corporate earnings would get buffeted given import duty protection increases and corporate taxes are cut.
- Higher bond yields could make inflows into EMs negative
- Policy focus away from China implies China equities lose money. China being a large part of EM basket, the basket loses money, resulting in further continued selling pressure in EMs.
- Fundamentally, India is expected to benefit. However, it could also see FPI selling on back of EM funds outflow
- Focus on defense globally would increase
The current move away from EMs into the US can be seen as a short term reaction to a long term trend. Longer term, on account of a large US debt stock, high continuing fiscal deficit, diversification of country reserves away from USD on global geo-politics, possible slowing of bond re-purchases, might all result in gradual weakening of the USD vs other currencies.
In this context while investors and investment managers are taking money to the US tactically, the bulk of the money invested into other regions may be retained, as investors would want diversification benefits. India is amongst the best performing global market, is cheaper than the US on valuations on many counts and has depth to allow large sums of money to be invested and taken out. While FPI selling pressure is high, it is showing signs of reduction. We believe that FPI selling pressure below Rs.3kcr on a daily basis can still allow the market to perform.
Domestics are buying, FPI sales may continue to be strong as is supply of paper
While domestic investors continue to pour money into the mutual fund industry and that has sustained buying by domestic institutions, Domestic investors continue to build equity allocation into their portfolios through SIPs and are taking advantage of market correction. Net flows into MFs were stronger in the month of October.
FPIs selling has continued. While October saw a record selloff, mid and small caps have weathered the storm better. November has yet seen lots of Midcap and small cap sell off.
Supply of paper continues to be high while the peak monthly supply is probably behind us as large IPOs of Swiggy and Hyundai are concluded. Supply of paper is also taking some steam away from the equity markets. Fund raise through QIPs may continue to be strong.
Fund raise by corporates fuel economic growth and act as pressure valve for the markets allowing for orderly discovery of valuations.
Valuations
Valuations have corrected. Market has been at the level first seen 6 months back. In the process, valuations have seen a near 6% correction. In the same period, US market has continued to remain strong. This has resulted in US market now trading at a premium to the Indian market on some valuation parameters.
We continue to think that Indian market valuations are sustainable. Outlook going forward for earnings is better than first half as government spending re-starts and benefits of a good monsoon percolate down and volatility associated with regime change in the US settles.
It continues to be time for Alpha
Change of guard in the US could have a positive impact on two largest sectors in the country- Banks and Software Services. Banks would now get to enjoy higher bond yields and the pressure on NIMs1 might get reduce. Software services last time got impacted by lower H1B visa issuances but this time around the industry has de-risked by having more onsite personnel, reducing the need for H1B. While the risk is lower, the business may get positive tailwinds from lower taxation enabled spending. Hence, the regime change is overall a positive for the market indices.
At the same time, higher bond yields is resulting in a large FPI sell off and it is now impacting the mid and small part of the market also.
If we look at our holding companies, most of them have delivered strong numbers and have a positive growth outlook. We continue to believe in longevity of growth in spaces like new tech, renewables, electronics, luxury, capital markets, mid cap IT, etc. and are using the downtick to build positions. We believe that while the index may do relatively better as Banks and IT finds feet, the earnings growth differential in our part of the market is high enough and overtime the market would reward higher sustainable earnings growth just like market did with software companies in the 1990s when they were delivering strong growth.
Thank you
Happy Investing
May the Good Times Continue
Data as of Nov’24.
Source: MOAMC Internal, RBI, MOIE, S&P Global, SEBI, NSDL, ValueQuest
1 Net Interest Margins
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