Dear investor
In this edition, let us discuss the following:
- Start of Fed rate cut cycle
- Institutional flows and supply of paper
- Risk Factors
- Time for Alpha
- Valuations
Fed rate cut cycle starts. Impact of global growth outlook changes on India.
Inflation has been coming down globally. Developed world has embarked on rate cutting cycle. Among advanced economies (AEs), Swiss National Bank (SNB) kicked off the rate cutting cycle first in March 2024. Subsequently, other major central banks – European Central Bank (ECB), Bank of England (BOE), and Bank of Canada (BOC) and Sweden’s Riksbank also started their rate easing cycles. The US FED has now joined the expanding list of central banks that have slashed interest rates, having done so on September 18th with a 50 basis point reduction in federal funds rate. Only Bank of Japan has hiked rates twice before and may hike again.
The rate cuts signal a belief that inflationary pressures are under control and cuts are required to support the labor market. The “dot plot” (which represents a committee members’ forecast for the federal funds rate) indicates an additional 50-bps rate cut in 2024 and a further rate cut in 2025, reflecting a continued probable easing of monetary policy1.
In the US, price rises have slowed to an annual pace of 2.5%, not far from its target of 2%. With oil prices sagging and rents rising more slowly, there is a good chance that inflation might ease soon. Hence, the Fed’s worries have shifted to the job market. The unemployment rate of 4.2% is low, but nearly a full percentage point higher than early last year. Unemployment could rise further as companies have pared back their hiring. Real estate sector in the US is seeing some signs of topping out.
This rate cut cycle is not in response to any large event but a response to loosening labour market and lower inflation. It thus, may not cause any concerns to arise. A rate cut cycle is good for emerging markets as more money flows into them seeking growth and higher yields. Currencies stabilize, forex improves, bond yields reduce and stock markets are buoyant.
India could be influenced less by happenings in other economies especially since our forex reserves are already at an all-time high and bond yields had already started to decline but coordinated global cuts may provide tailwinds to these trends. Expectations of a rate cut in India could also increase and we could expect the first rate cut over the next 3 months.
While growth assets such as equities benefit from decline in interest rate, different sectors behave differently. For example, decline in regulated rates is not good for banks because it pressurizes NIMs. Stronger earnings growth spaces should get tail-winded as growth money comes into the market. A drop in yields, coincides with Growth style of investing getting to the fore in the market vs Value style of investing. Our portfolios have an underweight on banks and have a high earnings growth orientation and may benefit from these tailwinds.
Institutional flows have been quite consistently positive. Supply of paper is also increasing
FPIs have been very consistent buyers in India. Over past 18 months there have been only 5 months where we have seen net selling by FPIs. The rise in India’s share in the global indices has provided a virtuous loop and now Indian weight in some MSCI indices is close to and over China. India has stood out amongst the emerging markets over the past few years. While other emerging markets have generated meagre returns, return from Indian stock market has proved to be much more consistent and has been amongst the best. This has been noticed as our markets are becoming less correlated to the world. Indian markets have offered strong returns, and are now increasingly liquid, justifying the purposes of diversification quite well.
Mutual funds have received inflows very consistently from March 2021. There has been no negative month of inflows on the mutual fund side. Insurance flows have been patchy. There is a strong flow and interest seen in the Dec to May period and less during other periods. Consistent flows and institutional interest has increased the depth of the market.
With markets remaining buoyant, IPOs and QIPs have flooded the market. In many months, the flood of IPOs and QIPs have matched the inflows into MFs. The money raised is continuing to rise. This is also supported by new investor additions in the market. New issues are the chosen way for new investors to come to the market and over 40lac of them are being added every month. As long as new issues continue to make money for investors, this virtuous circle may continue in the future.
Eye on Risk
Low oil prices, good and increasing forex levels, and now global rate cuts are all positive for India. Increase in yield by the Bank Of Japan induced a round of volatility last time it happened and could do so again. However, given the low exposure of Japanese investors in India (for them and for us), any such drop could present a buying opportunity.
It is time for alpha
One source of alpha creation in the market is advent of newer spaces with strong growth outlook. Markets follow earnings growth. Since the new space is not represented in the indices, they offer potential of alpha creation. This period has been very disruptive for earlier large incumbent businesses as technological changes have been rapid. Just like advent of online stores gave huge competition to brick and mortar stores in the past, EVs are giving a large competition to ICE. In spaces like two wheelers, the entire change from ICE (Internal Combustion Engine) to EV (Electric Vehicles) could happen in the coming decade. The past period saw the launch of the first pure EV two-wheeler company on the bourses.
The incumbents face a daunting task of preserving sales from legacy products which can slow down the adoption of newer products. On the other hand, the new companies which have adopted emerging technologies face no such issues, especially when they have crossed the proof of concept stage and have a good balance sheet.
We have aligned our portfolios with the businesses in the new emerging spaces such as new age tech and digital, EVs, Renewable energies, defence, luxury, beneficiaries of unorganized to organized, etc
Valuations
Valuations on large caps are at 10 year average and are sustainable. This is the time, when we can argue that valuations might be higher than long period average as growth in earnings remain higher than the long period average and discount rate has started to drop. On Discounted Cash Flow basis, a 1% higher earnings growth for 10 years is a 5% higher PE valuation. On this measure, midcaps are building in 11% higher earnings growth vs Large caps and small caps are building in a 3% higher earnings growth for a period of 10 years. This we believe is sustainable especially because many of the new growth themes are present in these growth spaces.
Thank you
Happy Investing.
May the Good Times Continue
Prateek Agrawal
Executive Director
Motilal Oswal Asset Management Company Limited
Disclaimer: Data as of Sep’24. Source: 1US FED, JM Financial Research, CLSA, Bloomberg, RBI, Quantum Research, Refinitiv. Disclaimer: This article has been issued based on internal data, publicly available information, and other sources believed to be reliable. The information contained in this document is for general purposes only and not a complete disclosure of every material fact. The Stocks/Sectors mentioned herein are for explaining the concept and shall not be construed as investment advice to any party. The information/data herein alone is not sufficient and shouldn’t be used for the development or implementation of an investment strategy. It should not be construed as investment advice to any party. All opinions, figures, estimates, and data included in this article are as of date. The article does not warrant the completeness or accuracy of the information and disclaims all liabilities, losses, and damages arising out of the use of this information. The statements contained herein may include statements of future expectations and other forward-looking statements that are based on our current views and assumptions and involve known and unknown risks and uncertainties that could cause actual results, performance, or events to differ materially from those expressed or implied in such statements. Readers shall be fully responsible/liable for any decision taken based on this article. The graphs used are to explain the concept and are for illustration purposes only and should not use for the development or implementation of an investment strategy. Past performance may or may not be sustained in the future. Investments in the securities market are subject to market risks, read all relevant documents carefully.
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