A Period of Euphoria or actual Bullishness? (Investment Outlook 2024)

As we say goodbye to 2023, it is commendable to see how resilient the global economy has been, more than what we expected at the start. Despite severe monetary tightening witnessed by the markets, leading to a broad-based correction in the first half. Year to Date (YTD) Dow Jones is up 13% with Nasdaq up by whooping 44%. And at 3% Global GDP growth, we surpassed the expectations by 1 percentage point.

Three key factors underpin this resilience:

1.       Robust Labour Market protecting the economy from high inflation.

2.      Delayed rebalancing in growth drivers

3.      Milder impact of monetary tightness in the US economy.

Looking ahead to 2024, the pivotal question is whether the runway left is long enough to ensure a soft landing in the US. To give context, whenever quantitative tightening (i.e liquidity squeezing) in the economy begins, it curbs demand which in turn helps the central bank in controlling inflation. At the last FED meeting, after a long time, the FED chairman hinted about an interest rate cut, which can be expected in the second half. As interest rates drop, borrowing becomes more affordable, potentially boosting overall demand. In the US, the majority of the rally happened in Tech based stocks with AI narrative associated with it. Hence, in 2024, the cyclical universe, which includes energy, chemicals, retail, can perform well as valuation comfort is present in them. Unlike 2023, asset mix balance will play a crucial role in preserving and growing your wealth. Gone are those days, where interest rates were close to 0, hence bonds might provide good yields to the investors. 

Fig. 1 - Returns Across Globe

Coming to India, Nifty50 has performed above long-term average giving 18% returns YTD. Further, Small caps and Mid-caps saw a massive rally with midcap up 43% and small cap up 52%. Sectoral - Pharma, IT, FMCG gave 30%, 24% and 25% respectively. 2023 was the year of PSUs, especially in the sector of Banking and Defense. Investors are bridging the valuation gap between PSUs and Private companies, looking over the cleanup which took place over the years and rise in profitability. I can be wrong, but I still hesitate to invest largely in PSUs, because unlike Private sector companies, PSUs might not have profitability as their first priority which can hurt the stakeholders. But all said, sentiments remain bullish in the markets when investors have confidence even in the public sector of a country. The narrative, “This is India’s Decade”, is getting reflected in the prices. Indian markets today are more resilient than ever as DIIs in just one year has infused 1.67 lakh crore rupees in the market. Even with strong FII selling, markets showed strength and achieved ATHs. We might even be at a stage where taper tantrum is no longer a major issue for Indian markets.

Fig. 2 - Nifty50 Technical Chart

With markets hitting all-time highs, the question which arises in Indian investors is whether this is euphoria or actual bullishness. Capital Mind's study indicates that the current bullishness is supported by fundamental improvements, including declining debt levels, reduced GNPAs, record FDI, and a trend towards import substitution.

Now to have a 360 outlook, we will study two key aspects.

1. Economic Growth

2. Valuations 

Fig. 3 - India’s GDP Growth post Covid

India has been the fastest growing major economy in 2022, growing 7.2%, with 7.8% growth in Q1 FY2023-24.

Fig. 4 - China VS India Manufacturing trend.

India is currently seen as a substitute to China for an alternative global supply chain. Favorable policies, cheap labor and infrastructure push, is giving China+1 a strong leg to stand on.

Further, India is sitting on 20-month high forex reserves which shows that money is flowing into the Indian debt and equity markets. The Indian Bond market was the talk of the town as it got included in the JP Morgan Emerging Market Index, which can channel around 25-30 billion of foreign funds to our government bond market. This can help in reducing the borrowing costs, stabilizing rupee’s valuation and enhancing the market’s depth. According to CRISIL, the Indian Corporate Bond market can double in the next six years. This gives retail investors an alternative investment option to park their money to preserve wealth. To embrace "India's Decade," the government needs to leverage the demographic dividend. This involves upskilling the labor force and building robust infrastructure to maximize the potential of India's workforce and ensure long-term economic growth.

Fig. 5 - Indian Companies Gross Debt to Equity (to check leverage)

On the micro level, Indian companies, both private and public, are establishing robust foundations. Post-scams, PSUs banks have undergone cleanup, evident as seen in declining non-performing assets. Additionally, Indian midcap firms boast record cash reserves with debts lowered from 24% in 2006 to negative debt of 9% (meaning cash reserves more than debt), while small-cap companies lowered debt levels from 33% in 2006 to 2% currently. This indicates a substantial improvement in the corporate health of Indian companies over the past decades. Consensus Nifty earnings estimates for FY 25 and 26 stand at 1100 and 1250, respectively, compared to the current 950. With the same P/E or valuation multiple, this implies a potential index rise of 15% and 31%, respectively.

Fig. 6 - Export Data 2023 (Aug)

Throughout 2023, export-oriented businesses, including chemicals, textiles, and autos, faced significant challenges. The prospect of interest rate cuts in the USA and globally hints at a potential revival in exports. With reduced working capital, these companies may experience a boost in profitability.

However, predicting the export segment is complex due to uncertainties regarding other countries' actions. For instance, Indian chemical companies were adversely affected in the previous two quarters. A drop in local demand prompted Chinese chemical companies to export commodities at lower prices, causing oversupply and price declines. China's ongoing economic challenges, including property deleveraging and factory closures, underscore the need for caution in navigating the export landscape.

I see 5 major themes playing out in 2024.

1. Exports: Anticipated rise in export pace.

2. Financialization: Indian investors seeking higher returns, drawing the financial sector into a sweet spot.

3. Energy Transition: 70-80% of new power generation is expected to come from renewables.

4. Manufacturing: IPOs in drone and electronic manufacturing indicate a growing trend, with policy push towards manufacturing.

5. Travel & Tourism: Expected dramatic rise with strategic marketing showcasing India's beauty, with estimates of 4.7 billion people.

Let's delve into the valuation dynamics.

With a drastic rise in indexes, even backed by strong fundamentals, it is very vital at what price we are entering into the market. Understanding the relationship between valuations, earnings, and market liquidity is pivotal. Valuations typically peak when both earnings and market liquidity reach their zenith Hence, we need to assess our investment decisions from both these perspectives.

Coming to profitability -

Fig. 7 - Return on Equity of Nifty500

Fig. 8 - Corporate Profitability

So, as we can see, the ROE of Nifty 500 was at its peak at 20% and has been declining ever since, further it again peaked at 15% in 2021 after which we saw a massive correction in the market. This data backed by Nifty earnings consensus shows that there is still room for earnings growth in Indian Companies.

Fig. 9a - Nifty 50 – P/E; Median P/E – 19.8

Fig. 9b - Nifty 50 – P/B; Median P/B – 3.2

As we can see both P/E and P/B for Nifty50 don’t look overstretched and are at long term averages. This shows that valuation wise, despite a rally, we are not at overvaluations. But certainly, we can say that this is not a period where we can expect extraordinary returns from the market.

Fig. 10 - Bank Nifty – P/E Chart

Fig. 11 - Nifty500 – P/E Chart

The Nifty 500 and Bank Nifty indexes echo the broader market's stable valuations, but a divergent trend emerges in midcap and small cap indexes. SmallCaps 100, currently at a P/E of s22 (peak at 24 in April 2021), raises margin of safety concerns, posing an unfavorable risk/reward scenario. But despite this there will be deep pocket opportunities, which Investors need to look for. 

Concluding we can say -

The coming year appears promising for stock markets, with potential interest rate cuts in the US and stable fiscal policies from the RBI.  Markets will be highly volatile as disruption risks are still present across the globe, if soft landing becomes hard. India also can have a pre-election rally, with signs of stable government visible after state elections. As we transition to a new normal, characterized by stable but higher interest rates, prudent asset diversification will be paramount. 

Disc. -

Not an Investment Advice, views are purely personal and for educational purposes.

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