Dear Investor
In this edition we discuss the following:
• Correction phase in the market
• Macro data has seen some weakness
• Result Season: Mid cap IT, EMS and Retailers have done well
• Valuations and it continues to be time for alpha
• Our portfolios have seen a correction
Correction phase in the market
CY25 has started with a sharp correction. Bond yields in the US sharply climbed to over 4.8%. FPIs have been strong sellers in Jan after being marginal buyers in Dec. However, as against large caps falling relatively more in a period of strong FPI selling, a variation in this period of correction has been a sharp drop seen in the midcap and small cap part of the market. The correction could have been on profit taking after a strong rally, FPI selling on bond yield increase and INR depreciation, end of year considerations of retail and HNI investors and margin call based selling on price drops. India has been amongst the weaker markets globally in this period.
However, domestic investors continue to invest strongly. Domestic MFs continue to match FPI selling and also absorb strong flow of new equity issuances.
Macro, possible policy responses and impact on market
On the economic front while most indicators seem to be within comfortable range and inflation has fallen, there has been a continued dip in forex reserves. INR has depreciated against the USD. Israel and Hamas situation seem to be stabilizing. However, versus lower oil prices expected on account of lower geo-political risk premium, opposite happened on account of stronger US sanctions against Russian oil exports. Higher oil prices are negative for India. Moreover, if the country is unable to source cheaper Russian oil, it would result in lower margins for the refining industry.
Oil prices have receded after change of guard in the US. Bond yields in the US have also declined from their peaks while they are still very high. We believe that US yields are very high in the context of growth of the economy and are expected to cool off over time. We should expect FPI flows to strengthen as the currency stabilizes and US bond yields cool off.
US has levied tariff on Canada and Mexico and has threatened a 100% on BRIC nations if they go forward on their plan for an alternate to USD. Illegal immigrants are being deported and citizenship by birth is being reversed. However, these measures do not impact us in any significant manner. We wait to see if there is a duty action against us which is disproportionate to competing nations for exports.
There are FTAs (Free Trade Agreements) with the west which have been talked about. Many of these FTAs lost momentum on changes in the regimes. With new regimes in place, we expect to see renewed momentum. We think our cost structures are much better than the west and such FTAs might work out much better for us vs FTAs with say the East where cost structures were very similar. We expect market to celebrate FTAs with west.
Result Season: Mid cap IT, EMS and Retailers have done well
Quarter 3 result season has started. We believed that there has been an uptick in the economy post monsoons. We believed that the Q2 slowdown was on account of lower government spending and higher monsoon intensity. Data is now coming in stronger. IIP has improved sequentially. Many retailers have shared the business update for quarter 3 and have reported strong same-store growth(‘SSG’). Few banks and IT companies have also declared results. We had hoped for an improvement in these spaces. We had noted that proposed US policy changes is good for these two large spaces. Banks could see NIMs stabilize relatively as interest rate cuts have been pushed into the future. IT companies could see a more hopeful trajectory on expected better US corporate spending on corporate tax cuts. While this quarter results for IT companies have been overall on expected lines, the commentary has been hopeful. Results from midcap IT companies have been good. Quick commerce companies have seen improvement in margins and are investing strongly in growth.
While results have been in some cases better than expected and management commentaries continue to be positive, yet the market has seen very sharp cuts in prices in many names, especially in the high growth spaces. Amongst other spaces, we believe that banks are now a mature businesses with growth rates of private sector and public sector converging and believe that valuations may reflect the new growth realities, rather than be focussed on the past. IT space continues to show a sharp divergence between large caps and select Mid and small cap performance which is reflecting in valuations as investors are more convinced about the sustainability of growth of these select companies.
Valuations and it continues to be time for alpha
This is a period of change. US has seen a president change. Our budget is being presented on Feb 1. Changes bring with them a period of adjustments. Portfolio which has anticipated the changes well may have a higher chance of outperformance. Towards this, we have brought down our exposure to government capex driven spaces as we think that higher allocation vs FY25BE would be difficult as government has to deliver on fiscal consolidation. We expect to see lower FY25RE in heads like irrigation, defence and railways and on these lower numbers, the budget (FY26BE) may provide a decent increase. Ordering could be strong in these spaces to use up some of the FY25 budget which is unspent. However, clearly, going forward, the focus could change from receiving more orders to executing the received orders, depending on various market and economic conditions.
We have positioned our portfolio into spaces, which are seeing strong tailwinds. Renewable is a global movement against climate change. With renewables come transmission infra. Defence needs have gone up considerably after Russia Ukraine and geo political tensions between China Taiwan. Indian defence products are finding more global markets. Per-capita income improvements are making Luxury sell stronger. Consumer and financial tech companies seem to be gaining share over brick and mortar. EMS companies are nicely positioned. Electronic imports are India’s second largest imports after oil and the need to source domestically is high. It is also a space where labour absorption can be high. Garments also present an opportunity on turmoil in Bangladesh. Capital market companies are benefiting from India moving from a country of savers to a country of investors. Our portfolio has a good representation from these spaces. While Banks and software services may see improvement vs the earlier outlook, the growth expected would be lower than the index earning growth. These spaces are less present in our portfolios. The other spaces which are less present are commodities.
While large cap indices are trading at long period average valuations, the spaces that our portfolios are built of are demonstrating stronger earnings growth. We believe that markets follow earnings growth corrected for valuations and there is potential for good alpha generation from the high growth segments of the market subject to market conditions and other uncertainties. We note that the Value style indices have started to falter after 4.5 years of strong performance from the bottom of covid.
Our portfolios/funds have seen a correction
Our portfolios had a relatively good Sep-Dec 24 period. However, our portfolios had a relatively weaker January. This was on strong selling pressure on growth stocks. There are many reasons for this and we have touched in the opening paragraph itself. End of the year is a period when the mid and small cap part of the market does see heightened volatility. Maybe this period has come a tad earlier this year. We do expect the volatility to remain high till March’25. However, given that our funds have seen performance normalize after sharp cuts in many funds, we expect we have a better chance of delivering alpha again as we go forward, although market conditions remain uncertain. We have looked into our holdings in light of the correction and continue to believe that our portfolios are well positioned for growth while some risk containment measures would be taken over a period of time.
We do expect a budget where fiscal consolidation is the focus and a Direct Tax Code may be rolled out. Fiscal consolidation could provide greater room to RBI to cut rates, especially if the forex situation improves and stabilizes. The contours of Direct Tax would have to be discussed. If equity related taxation reduces it would be a positive as would an effort to put more money in the hands of the people. Drop in oil prices is a positive and any reduction in global interest rates would be a positive. These factors all provide tailwinds to growth investing which is our focus. While these factors are external, we believe that the business growth of our investee companies, may continue to be strong, and this provides the better reason for alpha in the coming period. The correction provides a good opportunity for investors to invest.
Data as of Jan’25
Source: Bloomberg Consensus, Jefferies, RBI, MOFSL, Nifty Indices
Thank You
Happy Investing
May The Good Times Continue 😊
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