Daily Voice | This investment expert expects RBI to keep a hawkish stance on inflation

I split stock market returns into two parts: (1) investment return, which consists of dividend yield plus subsequent earnings growth (intrinsic value), and (2) speculative return, which is the influence of shifting P/E multiples on stock prices. Over very long periods, there is a very strong correlation and durable relationship between market returns and growth in earnings & dividends. However, P/Es oscillate (multiple re-rating), often with a remarkable impact on returns.

In the past decade & a half, equity investors have enjoyed extraordinary returns. But speculative return (P/E expansion) contributed significantly to the market’s return during this period. It is implausible to expect P/E multiple expansion to duplicate that performance, nor to provide any significant impetus to stock investment returns in the coming decade, as the cost of capital is expected to stay high. Therefore, the primary source of stock market return is expected to be growth in corporate earnings & dividends (led by strong growth in nominal GDP).

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Viewing from this lens, India is a growth story as India’s economic growth should improve to 7-8 percent on a real basis and 12-13 percent on a nominal basis for the current decade, and possibly next. Our stock markets should mirror this nominal GDP growth over the overlapping period. The trailing PE of the Nifty 50 is trading at a ~ 5 percent premium to its 10-year average, but the expected higher growth prospects justify this slight premium in valuations.

Broad-based Chinese stock indices are trading at a ~ 10 percent discount to their 10-year averages as measured by trailing PE. However, this PE de-rating is a result of China's economy being beset by multiple structural problems (population decline, transition in economic drivers, increased centralisation) and its growth is expected to decelerate in the medium run. Recently, Moody cut China's economic outlook from 'stable' to 'negative,' citing continuing medium-term growth concerns and continuous property sector restructuring. Moody's forecasts China's GDP growth at 4 percent in 2024-2025 and 3.8 percent on average between 2026 and 2030. These growth predictions are well below the double-digit Chinese growth rates that the world has been accustomed to over the last three decades, making aggressive PE-rating unlikely in China's case. This slowing of growth will affect aggregate corporate earnings growth, which will have a bearing on stock market returns.

However, due to its sheer size and domination, China will continue to be an economic heavyweight, considerably contributing to global growth. In the long term, there are several unique Chinese firms (EVs, renewable energy, deep tech) that are actual technological pioneers rather than mere replicas of US tech behemoths. Therefore, investors shouldn’t take a binary call of exiting the geography completely if they have some existing allocations but should 'right-size' the exposure, if over-exposed.

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Q: What themes do you like the most for 2024?

I expect the performance of mid and small cap indices to revert to the mean and the performance of large caps to be stronger in 2024.

Particularly, financials across market cap have not participated meaningfully in the market movement CYTD. Nifty Banking was up ~3 percent CYTD ending November 30 compared to NSE 500’s ~16 percent gain. Financials are well poised given the economic environment and their relative valuations.

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Q: Do you see the rally to continue in Indian equities if the US dollar index and 10-year treasury yields decline further?

Yes, the YoY October 2023 CPI release in the US indicated that interest rates have peaked or are close to peaking. However, we do not anticipate a sharp rate decline triggered by the Fed in the immediate term, and overall rates are expected to remain higher for a longer period.

If yields continue to fall in the face of an improved macroeconomic and geopolitical climate, it would be a positive for flows into emerging markets, of which India would be an obvious beneficiary. However, we believe that the global macroeconomic condition and growth, as well as the uncertain geopolitical scenario, remain a source of concern and we are not out of the woods yet.

Any additional worsening in the global macroeconomic and geopolitical situations would result in risk-off sentiment, which would be negative for EM flows.

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Notably, it is not simply the decrease in US long-term yields that is driving the surge in Indian equities. Strong earnings growth, strong GDP growth numbers, moderation in inflation, general macroeconomic stability, moderation in broader market valuations, and substantial sticky domestic inflows have all contributed meaningfully. Add to that the perception of political stability & policy continuation and the persistence of an accident-free global environment, we might continue to see strength in Indian equities till such time such conditions reverse.

Q: Do you think the valuations are still reasonable in the real estate space?

We do not provide sector/thematic perspectives, but I will provide a very broad take on the sector.

On a CYTD November end basis, real estate has been the highest-performing sector this year. With this price increase, the Nifty Realty sector as a whole is trading at a considerable premium to its 10-year average. As a result, overall valuations have become stretched to some extent.

Valuations should be viewed in light of the anticipated growth in the sector. Housing demand is growing at a healthy clip, and with interest rates likely to moderate in the next 1-2 years, a good demand and supply situation, robust inventory absorption, and pricing power, I expect buoyancy in the real estate sector to continue.

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It’s important to take a stock-level call on valuations instead of painting the entire sector with the same brush as market share gains and growth rates will differ significantly within the sector.

Q: What do you broadly expect from the central banks commentaries in December - particularly the US Federal Reserve and Reserve Bank of India?

The RBI is expected to keep a hawkish stance on inflation notwithstanding the recent dip in inflation and reiterate their aim to bring down retail inflation to 4 percent print.

In a similar vein, the US Federal Reserve is anticipated to restate its resolve to rein in inflation and bring it under control. Towards that end, the US Fed may continue with its stance of keeping rates higher for longer till such time inflation is under control durably.

Q: Has the market over-reacted to the state elections results and economic growth numbers?

I don't believe the market overreacted to the results of the State elections. Markets were firming up even before the State election results on the back of good macro and growth numbers and some moderation in the global geopolitical situation, and that buoyancy was aided further by State election results.

Markets were not discounting such a sweeping victory for the ruling party at the centre, and markets were pleasantly surprised by the nature of the victory. Importantly, political stability is an essential criterion for foreign investors, and those sitting on the fence may advance their entry into India before the outcome of next year’s elections based on these results, as these results likely lessen the probability of a huge upset in general elections next year.

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