Dear investor
In this edition, let us discuss
- FY24 ends on a good note
- Quarter 4 result season
- Reasons for market volatility, what is causing volatility in the present
- Capital market theme
- Valuations
FY24 ends on a good note
India is set to exit FY24 with a GDP of USD3.6t and an underlying growth of 7.6%+. Capital markets signed off FY24 with a stellar 29%/60%/70 % returns in Nifty/Nifty Midcap 100/Nifty Smallcap 100. India’s market cap has reached USD4.4t, making it the 5th largest in the world. Over last 10 years, our GDP rank has changed from 10th to 5th, current account deficit has reduced from 1.7% to 0.7% and forex reserves have expanded.
India is currently experiencing a mini-Goldilocks moment due to solid macroeconomic conditions, healthy corporate earnings, peaking of interest rates, moderate inflation print, and ongoing policy momentum.
We are less impacted by global events and uncertainties because of robust domestic growth and higher forex reserves as a percentage of GDP which acts as a dam between the volatility outside and the Indian economy.
Quarter 4 result season: Key trends and expectations
Our Institutional equities team expects its coverage universe and NIFTY earnings to grow 6% YoY each in 4QFY24. Excluding global commodities (i.e. Metals and O&G), the MOFSL Universe and Nifty would post 12% and 9% YoY earnings growth, respectively, for the quarter. We have been pointing out that the broader universe earnings growth for several quarters now has been more than Nifty, a trend that has emerged from Covid lows. Till this trend continues, we believe it continues to be time for alpha.
Overall earnings growth is likely to be driven once again by domestic Cyclicals, such as BFSI and Auto. Private Banks and NBFC-Lending would mainly lead BFSI’s earnings, with 14% and 23% YoY growth, respectively. Earnings growth of Private and PSU Banks, at 14% and 12%, while healthy, is the lowest in 10 and 8 quarters. The Auto sector’s earnings are expected to grow 20% YoY, amongst the best performers within Coverage sectors.
As yet we have seen results from a few auto, broking companies and IT companies. Aggregate volume numbers for jewellery, retail and housing spaces have shown strong trends. Trends in stock market volumes did point to a robust number from broking companies and that has been the case. IT companies went into the quarter with muted expectations but in some cases have still disappointed and the guidance for the next period also points towards uncertainty continuing for longer. IT companies are large incremental employers and a slowdown here does not portend well for the urban consumption growth. Employee strength has seen a drop in the three large companies which have declared results. Auto company results have been good.
Markets are at a high. Causes of current volatility in the market and how are we positioned for the same
Market large cap indices hit a high on 10th Apr 24, of 22775.7. At this juncture, let us examine the short period outlook for the markets.
It is the nature of the markets to be volatile and surprise the investor. A positive volatility is liked while negative causes concerns amongst long only investors. A 3 to 5% correction is common and can happen anytime and indeed has happened multiple times over the past 1 year while overall the year has seen strong equity performance. Such periods were Sep/Oct of last year, Jan of 24, Mar 24, etc.
Causes of market volatility are many and can take the shape of, amongst other reasons, the following:
- Sharp changes in expectations. For example interest rate cuts vs rise, corporate margin changes on commodity price change, etc.
- Changes in policy makers/ policy making environment eg for some reason China +1 no longer remains the dominant sentiment
- End of year considerations which causes volatility in feb/march in most years.
- Geopolitics which can lead to spikes in commodity prices in general and oil prices in particular
- Volatility on account of reform uncertainty and tax changes on domestic / offshore investors
- Volatility on account of earnings missing or exceeding expectations.
- Trading margin change related volatility
- Strong short period rise in stock market investments on index weight changes and normalization there-after, etc
Recent volatility in the market has been caused by the yield spike in the US, INR depreciation and spike in oil prices as a consequence of heightened geopolitical concerns and some changes reported for Mauritius FPI taxation structure. We had shared in the past our tolerance levels on oil in the Nov 23 edition and believe that economy should be able to sustain even at oil at USD105/bbl. Since then, the current account deficit has improved and forex reserves today are at an all-time high, further improving our ability to withstand short term shocks. Moreover, since we did not decrease petro product prices when oil was closer to USD75/bbl, the need to increase it now is not there, further keeping the economy insulated. In the event of the flare-up remaining contained (i.e. not impacting the flow of oil and assuming trade channels remain open which is our expectation), the dip in the market should prove to be an opportunity (on this risk).
Higher interest sustaining for longer is a headwind for growth style of investing. However, Indian interest rates are close to average of last decade. It is US interest rates which have spiked up. Spike in US interest rates implies
- Prospect of lower growth there and to mitigate that risk we have kept focus on domestic businesses and
- lower/negative FPI inflows.
- INR depreciation may cause some FPI selling in the short term. However, INR depreciation is good for corporate margins in the medium term.
- Spaces where FPIs are more present are Banks and Tech Services and these spaces could continue to see some more selling pressure. We are less present in these spaces.
- Since our forex reserves are at an all-time high, FPI selling should not prove to be an issue. Moreover, as we have been pointing out, Indian capital market story increasingly is about structural domestic flows coming into the market and is no longer FPI dependent.
Election outcome related uncertainty is low at this juncture. Volatility can be expected around election result time if the outcome is significantly different vs expectations. Post elections, first budget of the new government would be closely watched.
Our portfolios are built of businesses positioned in line with the general policy direction and benefits from growth tailwinds. Moreover, heightened geopolitics may cause reduced market access to manufacturing entities in some locations and impact export oriented businesses. Our portfolio is more domestic business focused and should be less impacted. We believe we are well positioned in the alpha themes and believe that market dips offer great entry points.
Capital Market Theme
We have discussed two of our themes in our last two editions, Premiumization and China+1. In this edition let us discuss the capital market themes. It is a space which is well represented in most of our portfolios. Key driver of the theme is the evolution of India from being a country of savers towards being a country of investors. Better income levels are leading to financial surpluses on which investors can take a measured amount of risk in the quest of better than bank returns.
The growth runway is long. If we look at the total PAN cards issued in the country, the number of demat accounts are less than 1/4th of it and number of Mutual fund subscribers are less than 1/3rd of the number of demat accounts. This clearly indicates the long runway of growth in terms of market penetration itself. Higher activity from market participants would be the other driver.
The ecosystem comprises of Stock and Commodity exchanges, Mutual funds and Alternate
asset managers, Brokers, backend services providers (Demat, etc), Wealth advisors and distributors amongst others.
Indians have been underinvested into equities and equities contribute to sub 4% of household assets. Strong market action over the past period has brought the asset allocation closer to 5% currently but it is as yet very low vs other countries in the region. As the chart shows, the good news is that the journey of better capital market participation has started. Number of demat accounts have tripled over the past 3 years and yet the penetration levels are a third of China. Market participation is seen higher in richer states like Maharashtra, Gujarat and Delhi. Strong economic growth in poorer states should rapidly increase participation from there. This implies sustained long period growth.
Improved investor participation is leading to a surge in cash and F&O volumes on the exchanges, inflows into MFs and alternate funds, and into assets advised by wealth managers and distributors. This is leading to strong sustained improvement in revenues of exchanges, MFs, Wealth managers/distributors and brokers and back end service providers.
Many of the entities such as MFs, Exchanges and Brokers are very scale-able system driven platforms and a large part of increase in revenues drops to the bottom-line. This makes the whole space quite attractive for investments.
Of the various spaces in the capital market ecosystem, businesses linked to increases in trading volumes are experiencing better predictability (a contrarian view). Volumes are increasing as a consequence of higher ticket size (one share priced higher with time), more participation of population, higher frequency of participation and is aided by volatility in the market itself. Futures and option volumes are sharply going up on leverage, speculation and hedging considerations. Overall upward trending markets with some volatility are thought to be good for volumes. Monopoly businesses like exchanges are well positioned. In the past, brokers saw intense pricing pressure in the past which seems to be subsiding. The space has seen large consolidation. This is increasing the attractiveness of the space going forward. Key risk here is a flat market with low volatility which can cause volume reductions.
Next in the food chain should be AUM based businesses such as asset managers and distributors where growth is linked to market moves and fresh net inflow (which is taking the structural shape with SIPs), followed by the back end service providers. Overall, this theme should see earnings growth sustain higher than nifty index growth for multiple years. As a house, we have positioned our client monies into exchanges and brokers.
Moreover, some of the larger entities are tech platforms. They have aggregated a more affluent cohort of Indian population on their platforms. Over a period of time cross sell opportunities in the financial space would arise and could take the shape of sourcing, lending and insurance. Already some brokers are attempting the same, further increasing their TAM.
Expectations after the new government formation
Election process is expected to be completed by June resulting in formation of a new government. Given the widespread expectations of return of the policy makers, the policy roadmap should be expected to remain on the set path. Few expectations are as under:
Increase in prices in a few spaces: in the run-up to the elections, inflation and price rise gets higher focus and price increases are deferred where ever possible. Post elections normalisation is expected to take place. Two spaces where we do expect some price increase attempts are telecom and cement. Telecom sector is seeing renewed focus with successful fund raise of Idea Vodafone increasing the sustainability of a 3 player market. Post elections both Bharti and Vodafone are expected to raise tariffs on profitability and sustainability. JIO is expected to follow suit given that it already has a dominant market share and there are expectations of listing. Cement players are also expected to attempt price increase post elections as has been the trend in the past.
Newer spaces under PLI: Government has been rolling out PLI benefits to catalyse investments into spaces where the country may be suffering from competitive disadvantage with mixed results. Electronics PLIs seen as a success and items like cell phones, laptops, TVs, air-conditioning, etc. are now increasingly made in the country. For the success to continue after the PLI period is over, it is necessary to have component ecosystem also in the country and there are expectations of more incentives for spaces like semiconductor components, OSAT, Li batteries, etc where more players may be included.
Defence indigenisation should retain its focus given the geopolitical scenario and we expect more items to be put in the Make in India list.
Focus on capex should continue. Make in India is a big push of the current government and while PLIs would help set up manufacturing infrastructure, infrastructure capex would help logistics within the country and outside. Investments in rail tracks, new higher speed railways, better and new roads should continue.
Privatisation is expected to find focus again. We have seen strong up-move in government businesses in the stock markets. Some businesses such as BEML, Concor and IDBI bank were listed to be divested in the past. Post elections, one can expect some of these to be done. Similarly coal block auctions to enable rapid scale up in coal production should be expected.
Overall, the policy roadmap set over the past few years should continue to be followed.
Valuations
Given the sustained strong growth in economy, good macro outlook, and continuity of policy making we continue to think that valuations should sustain.
Geopolitical events if they sustain for longer and cause disruption in global trade and a spike in oil prices could impact the picture as could a sharp move up in equity valuation. Else, with reverse globalisation corporate India should be able to positively surprise on the manufacturing side both in terms of volume growth and margins. Large cap valuations are close to average valuations and earnings growth related compounding should continue to be expected from this space. Mid and small caps are the key beneficiaries of the new policy direction and are experiencing better growth in earnings after a long time vs the large cap peers. If the growth delta sustains in favour of mid and small caps, this space can sustain higher than long period valuations. Overall, we do believe that buying on dips should continue to be a good strategy. A 5% dip happening over a quarter, corrects close to 10% valuation on account of continuous compounding of underlying earnings.
Amongst the themes which are present in our various portfolios, we expect defence to find new focus on account of geopolitical situation. Chemical sector has not performed over past one year and there is now hope that the inventory de-stocking cycle is now behind us which is improving sentiment here. Themes like luxury consumption and capex should hold out during the election season quite well and good monsoons (expected on La Nina) should help. EMS space should benefit from new PLI rollouts once the new government formation has taken place. Renewable space is seeing strong corporate sector ordering which is keeping the order books buoyant. We are less present in the IT sector where results have been weak.
Overall, we believe we are well positioned in the focus spaces and expect our investee companies to deliver a significant delta in earnings over the broad market.
Thank you. Happy investing
May The Good Times Continue
Prateek Agrawal
Executive Director
Motilal Oswal Asset Management Company Limited
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