The Indian market has been consistently hitting new all-time highs, reaching yet another peak this month. This surge is fueled by optimism about India's growth trajectory, increased liquidity, and growing domestic participation. However, it's important to note that there may be interim corrections in the near future, particularly with upcoming election results on the horizon.
Nevertheless, the long-term fundamental metrics paint an optimistic outlook for the Indian markets. Let's take a closer look at how various economic indicators are performing
Macroeconomy
India's economy is expected to grow by 7.3% in the fiscal year 2023-24, thanks to a strong performance in the second quarter. This growth is largely fueled by a significant increase of 37.4% in government spending on infrastructure and development projects, which now accounts for 4.3% of the country's overall economic output.
Looking ahead to the 2024-25 Budget, this spending is set to rise to 4.6% of the GDP, aiming to boost consumer spending and attract foreign investors, which should lead to further growth in the Indian business ecosystem.
Strengthening India's Foreign Exchange Reserves through Capital Influx: Despite a current account deficit in the first half of FY24, a substantial capital account surplus, driven largely by foreign investments, has bolstered foreign exchange reserves by USD 27 billion. Foreign Portfolio Investments (FPI) have seen a remarkable uptick, with an influx of USD 28.8 billion in H1 FY24, contrasting sharply with the previous year's outflow.
Foreign Direct Investment (FDI) also remains strong, with India attracting USD 596.5 billion between FY15 and FY23, thanks to its appealing investment climate, liberal economic policies, and strategic initiatives like Make in India. India's foreign exchange reserves are robust at USD 623.2 billion, ensuring import coverage for over ten months and a comfortable external debt profile at 18.6% of GDP.
Strong Foreign Direct Investment (FDI) Trend Continues: In the first half of FY24, although there was a deficit in the current account, foreign investments brought in a surplus of capital, increasing foreign exchange reserves by $27 billion. Foreign Portfolio Investments (FPI) notably increased by $28.8 billion compared to the previous year, while Foreign Direct Investment (FDI) remained strong at $596.5 billion between FY15 and FY23.
This is largely due to India's attractive investment environment, open economic policies, and initiatives like Make in India. Currently, India's foreign exchange reserves stand at $623.2 billion, covering imports for over ten months, and the external debt is manageable at 18.6% of GDP.
Equity Market
Market Performance : Despite some interim market corrections, the Indian equity market has shown resilience and strong economic growth, positioning it as one of the fastest-growing countries in the world. In January 2024, the Indian equity market displayed resilience with notable gains across major indices, reflecting positive investor sentiment and confidence.
The Nifty 500 and NIFTY 50 both experienced robust growth, paralleling the previous month's upward momentum. Similarly, the NIFTY Midcap 150 and NIFTY Smallcap 150 indices continued their strong performance. All major sectors contributed to the market's positive performance, indicating broad-based investor optimism. Despite heightened volatility, the market's strong breadth underscored sustained interest in Indian equities, marking a promising start to the year.
Valuations and Earnings Outlook: While India's equity market has performed well, valuations are relatively expensive compared to Asian peers. The priceto-earnings (P/E) ratios of large-cap indices, such as the NIFTY 50, are close to their 5Yr avg. valuation, which means, suggesting a potential rotation to large-cap stocks. Earnings outlook for India remains strong relative to emerging markets, driven by healthy credit demand and robust high-end consumption demand.
The below charts show that Nifty (proxy for Large Caps) is trading at a 12-month forward Price to Earnings ratio (P/E) of 20x, which is in line with its 10-year average. Indicating that Nifty50 is in the fair value zone. However, both the Midcaps & Smallcaps are trading at significant premiums to their respective long term average P/E.
With small and mid-cap stock valuations soaring, concerns have arisen about whether there's a bubble forming in these segments. The Mutual Funds Association of India (AMFI) has urged asset management companies (AMCs) to devise policies safeguarding investors involved in small and mid-cap stocks. There's a growing perception that valuations in the broader market might be overheating.
In 2023, small-cap funds attracted Rs 41,035 crore in net inflows, while mid-cap funds received Rs 22,913 crore. Conversely, large-cap funds experienced net outflows of Rs 2,968 crore. Following suit, several AMCs have either limited or ceased lump sum investments in their small-cap funds. Therefore, we're opting for profit booking from small and mid-cap investments, shifting towards more stable large-cap or equity-oriented hybrid funds.
Debt Market
India's bond market kicked off the year with record-breaking foreign inflows in the initial two months. This surge is primarily driven by the inclusion of domestic gilt in the JPMorgan Bond Index and the government's ambitious fiscal deficit target for the forthcoming year.
Foreign investments in Indian debt have totalled Rs 42,256 crore thus far this year, comprising Rs 19,837 crore in January and Rs 22,419 crore in February, as per data from the National Securities Depository Ltd. February witnessed the highest monthly influx in over seven years, surpassing the previous peak in June 2017 at Rs 25,685 crore. Since the announcement of the inclusion of Indian government bonds in the JPMorgan emerging-market index in September last year, the debt market has witnessed an inflow of over Rs 81,800 crore.
Intelligent Investor Notes
Equity
The current Nifty index is trading at a lower valuation of 22X earnings, presenting a favorable market compared to its 5-year average of 26X earnings. This offers favorable opportunities in equity at a reasonable rate.
Given the current lower valuations in the stock market, considering an investment shift toward the infrastructure and energy sector seems prudent, given the improved recent government allocation. Hence, we suggest allocating your funds to select infrastructure and consumption-oriented funds.
However, exercising caution is crucial, as the upcoming 12 months leading to the 2024 elections could witness increased market volatility, historically speaking. When contemplating investments in equity options, it's suggested to proceed judiciously and remain mindful of the uncertain political landscape. Here, we've been reallocating funds to more secure options such as large-cap-oriented equity funds, as large-cap has the opportunity to yield better sustainable outcomes in market consolidations and any pertaining market volatility.
Fixed Income
With higher interest rates, incorporating debt-oriented hybrid funds into your portfolio can help to potentially leverage by leveraging a blend of equities, arbitrage opportunities, & debt instruments. Along with the recent budget planning on the bond market, the demand for bonds is going to significantly increase, offering higher returns.
To mitigate the impact of fluctuations in interest rates, you can explore Medium Duration and Credit Accrual strategies. These strategies primarily concentrate on investing in securities with AA & AAA credit ratings while maintaining a portfolio maturity in the range of 3-5 Yrs. This approach can help in balancing risk & return in your investment portfolio."
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