Market so far gained 12 percent in current calendar year 2023. But, in the year 2024, "it is unlikely that index will deliver 10-15 percent return," Varun Lohchab, Head of Research - Institutional Equities at HDFC Securities said in an interview with Moneycontrol.
At the current juncture, he believes large caps offer better risk-adjusted returns than midcaps as the latter has appreciated beyond the levels explainable by its earnings growth. Large-cap stocks may deliver 5-10 percent upside from current levels, he feels.
With over 18 years in Indian equity markets, Varun Lohchab highlights two persistent themes: investment-driven growth and financialization of household savings.
Q: Do you expect the year 2024 to also provide 10-15 percent market return? What are the factors that will support the equity market?
Nifty is currently trading at a fair valuation of 17.6XFY25E, so risk-reward is balanced now. In our view, it is unlikely that the index will deliver a 10-15 percent return in 2024. At the current juncture, “large caps” offer better risk-adjusted returns than “midcaps” as the latter has appreciated beyond the levels explainable by its earnings growth. Large-cap stocks may deliver 5-10 percent upside from current levels.
Furthermore, as India’s GDP is poised to grow the fastest among emerging market countries and developed markets are expected to grow at much subdued rates in 2024, so foreign flows will likely find India as their preferred investing destination.
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In addition to this, domestic SIP flows will remain robust given rising household savings. These factors will extend support to the Indian equity markets.
Q: Do you see any major threat to earnings growth in next calendar year?
For the HSIE coverage universe representing listed corporate India, projected earnings growths for FY24E and FY25E stand at 29.2 percent and 7.5 percent (Ex-energy sector, 18.8 percent and 15.5 percent) respectively. The earnings growth figures are mainly led by energy, auto and financial services sectors.
Our current earnings estimates are dependent on a fair Brent crude range as per the current demand-supply situation. So, any unexpected spike in Brent crude prices led by ongoing geopolitical tensions may play spoilsport. Additionally, the financial services sector plays a pivotal role in aggregate earnings growth which is dependent on interest rate cycles.
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While domestic and global central banks have currently paused the ongoing rate hikes, any resumption of rate hikes will be detrimental to domestic credit growth and hence earnings of the banking sector.
Apart from this, 2024 being an election year, policy continuation dependent upon outcome of general elections is a major assumption and any alternate government stance remains a major risk to the earnings.
Q: Do you think the equity market started pricing in that the rate cut may start in the first half of 2024? Do you expect a dovish policy statement from the US Federal Reserve in December?
As we analyse, CME data about Fed’s rate outlook, we notice that the market has priced in a cumulative rate cut of 100-125 bps in 2024 but most of this is expected to come in the second half of 2024. We expect the rate cut cycle to begin only in H2 2024 and cuts to be calibrated and lower than currently priced in.
If we closely observe US consumers’ current situation, accumulated excess savings of US households have come down from $2.1 trillion at the peak of a pandemic to $0.4 trillion now. Furthermore, the personal savings rate has declined to 3.4 percent of disposable income from a pre-pandemic level of 8.5 percent.
Hence this buffer savings of $0.4 trillion is expected to decline further which will adversely impact overall consumer demand and growth. In this backdrop of expected weaker economic data, we anticipate US Federal Reserve to deliver more conclusive signals at the end of the rate hike cycle in this December meeting.
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Q: Do you expect the RBI to hint about rate cuts in the December policy meeting?
We expect the RBI to sound hawkish at its upcoming monetary policy meeting on December 8. The central bank is likely to revise up its GDP growth forecast for FY24 marginally but on the interest rates front, we expect it to start delivering cuts in H2 2024 only.
As domestic inflation indicators core CPI & WPI have been softer in the last few months, it has helped RBI in calibrating its policy on interest rates. Nonetheless, another variable in the RBI policy decision-making process is US Fed rate which is still uncertain.
So, we believe RBI will focus on protecting domestic currency and wait for a clear stance from US Fed on the rate cut cycle before it starts hinting about rate cuts. So, RBI’s stance is expected to be data-dependent.
Q: Is the US generic pharma space still looking reasonable?
We continue to be positive on the opportunity offered by US generic pharma space. Drug patent expiration and the need to reduce healthcare costs are driving worldwide demand growth of generic drugs. The current situation in US is suggestive of a product upcycle in the generics market led by patent expiry which could benefit several Indian pharma companies given their robust pipeline of products.
Additionally, post-COVID, with normalisation of inventory, the intensity of price erosion in US generics market has reduced which has improved the outlook of the segment. Improving demand outlook and stability of prices make us optimistic about the opportunity, which is expected to last for next 3-5 years.
Q: Which are the themes that will be on your radar for 2024?
The two themes which are consistently on our radar are the “investment-led growth in India” and the “financialization of household savings”.
The investment-led growth in India, which is demonstrating itself through higher public and private sector CAPEX, augurs well for the industrial and capital goods sectors. As per our ground checks, government is leading from the front in execution of capex which is encouraging private sector to follow suit. In our view, this is a multiyear cycle that will have a positive impact on several capex-linked sectors and forge a decadal growth path for the country.
The financialization of household savings is a by-product of a more financially educated demographic. As individual earnings and household savings pools are rising while returns delivery by physical assets are muted, so there is a natural inclination towards financial assets. This is reflected in robust SIP flows, life insurance & general insurance premium collections and strong direct equity trade volumes. We believe, given per capita income of India is at an inflection point, growth in this segment of financial products will accelerate from here.
Q: Do you think one should still wait for investment in IT space?
While we believe that the IT sector's performance has likely bottomed out, the demand outlook for IT services in Western markets is still uncertain. Most of the tier 1 IT companies have lowered their full-year guidance, and subsequently, the FY24 EPS consensus figures have seen modest cuts.
Furthermore, the discrepancy between the IT companies' order books and their billed revenues indicates the postponement of planned IT projects by clients. Additionally, real GDP growth of US is expected to decelerate to 1.0 percent in 2024 as against 1.9 percent in 2023.
With such a backdrop expected to persist for the next 12-18 months, earning visibility in the sector is relatively low. Hence, we would believe that one should wait for clarity in the demand outlook before taking an aggressive plunge in the sector.
Q: Do you expect valuations to remain high for the midcap and smallcap space in 2024 too?
In the recently concluded earnings season for Q2FY24, it was observed that large cap stocks dominated the incremental earnings delivery. Earnings of large-cap stocks of HSIE coverage universe grew by 37 percent YoY, while the same for mid/small cap category grew by a moderate 12 percent YoY.
Meanwhile, stocks in the mid and small cap space have seen a meteoric rise. In last one year, BSE midcap and BSE smallcap have delivered returns of 32.5 percent and 36.6 percent respectively while Sensex could deliver a modest return of 6.7 percent only.
Consequently, BSE mid and small cap indices currently trade at expensive valuations of 24.7x and 30.5x respectively. As the appreciation of stocks in mid and small cap space haven’t been supported adequately by commensurate earnings growth, we believe valuations for them will contract in the coming year.
Disclaimer: The views and investment tips expressed by investment experts on Moneycontrol.com are their own and not those of the website or its management. Moneycontrol.com advises users to check with certified experts before taking any investment decisions.
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