Deflationary conditions will emerge in FY24 thanks to monetary tightening and slowdown

The popular trades of the previous market cycle (2018-2021) may continue to see sharper valuation rationalisation over the next couple of years

I suggested yesterday (see 'A Perfect Storm') “the best strategy under present circumstances would be to (a) hold nerves and not panic (b) review the portfolio for any corrective action that may be needed once the storm passes and the sea becomes calmer".

To add to that, I suggest the following while reviewing portfolios:

1.    The higher cost of capital (interest rates) would result in lower fair valuation for equities in general. Growth companies that have debt on balance sheet or need to borrow for capex, and/or where the free cash flows are mostly back-ended, may see much sharper cut in their target multiples. In fact we have already seen 20% derating in Nifty PE Ratio over the past eight months.

2.    The market consensus was around 18% compound annual growth rate (CAGR) for Nifty earnings over FY23-FY24. Realised earnings growth may be much lower than this. My personal assessment is that we may end up with 10% CAGR over FY23-FY24.

3.    The popular trades of the previous market cycle (2018-2021) may continue to see sharper valuation rationalisation over the next couple of years. Many of these stocks may therefore not participate in the next market cycle.

4.    Monetary tightening, growth slowdown and consumption demand destruction shall essentially result in deflationary conditions in 2023-24. The strong earnings cycle for most non-food commodities may therefore not last much longer. The metal and energy stocks may therefore see sharper correction in multiples and fair value targets.

5.    A new market cycle is mostly led by market leaders till a new theme(s) emerges and the stocks from that theme(s) catch the fancy of market participants. It is therefore always better to be positioned in a large cap basket during the twilight of a market cycle.

In my base case assessment, the risk reward in Nifty from a one year perspective is positive at current levels.