Despite 20% rally in 2023, this CIO won't call it a very overvalued market, advises to focus on these 4 sectors

The Indian equity markets have experienced a healthy rise since the March 2023 lows, with the Nifty 50 TRI (total return index) rising 20 percent and Nifty mid-cap and small-cap TRI indices rising even faster by 47 percent and 55 percent, respectively, on an absolute basis. Today, the markets have touched new lifetime highs across the three indices.

What has been interesting about the rally is the breadth of the sector participation. Several sectors such as auto, capital goods, non-banking finance companies, life and general insurance, pharma, capital market, real estate etc. are touching new highs. Markets are a leading indicator of the economy. So, the rise of participation of various economy-related sectors in the equity markets possibly portends to an upcoming economic cycle. Given the above quality of the breadth of market participation, it qualifies as a strong market and is unlikely to peter out quickly.

Also, our markets are in a momentum of their own, aided in no small measure by domestic investors and flows to the markets. And as Newton’s first law states “an object will not change its motion unless a force acts on it”. So, for this market momentum to stop or reverse, it now requires negative news to stop the rally.

After the recent assembly election results, there is now a far higher probability being assigned by the market that the current political dispensation will continue after 2024.

This development should ensure the continuation of policies that support growth; thus, the market expects India to remain one of the fastest-growing major economies in the world.

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Political stability, strong economic growth, and the potential inclusion of India in global bond indices in mid-2024 can lead to the appreciation of the Indian rupee, which will lead to more significant FPI inflows in India, pulling markets even more upwards.

The $4 trillion Indian economy is emerging as the growth engine in an increasingly growth-starved world. What is enthusing investors is the predictability and the certainty of the long duration of growth in India. As a market, the appeal of Indian equities is rising.

Global interest rates, which have been rising since late 2021, now appear to have reached their peak. While interest rates may remain higher for longer, it is expected that central bankers are unlikely to raise interest rates further as developed markets' economic data is already weakening and inflation metrics are showing signs of ebbing.

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As investors, we observe that there is a high correlation between say, US 2-year bond yields and the Indian markets (interest rates work in inverse proportion to the price-earnings (P/E) ratio; as interest rates expand, P/E contract and vice-versa). So the narrative of the peaking of interest rates in the US, has driven an equity market Santa rally, including in our markets.

Sectors that may do well in this broad-based rally irrespective of the election outcome in 2024 are Auto, Financials , FMCG & Capital goods. The rationale for these sectors is as follows: -

Auto: It contributes 6 percent to India’s GDP and 35 percent of the manufacturing GDP. The EV (electric vehicle) market is expected to grow at a CAGR of 49 percent between 2022-2030 and is expected to hit 10 million-unit annual sales by 2030.

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Financials: The sector has significant scope for growth through market penetration and digitisation. The growth of fintech will help this sector tap the large rural market and the growing internet-savvy youth population.

FMCG: It is a stable and resilient sector, even during the global pandemic it witnessed consistent demand. An all-weather sector is likely to continue to grow and get an impetus from rising customer aspirations.

Capital Goods: This includes sub-sectors like electrical equipment, plant equipment, and earthmoving/mining machinery, heavy electric equipment, etc. that would benefit from the government’s higher infrastructure push and schemes like PLI (production-linked incentive).

Now, we need to look for risks to this market. Excessive valuations, rising oil prices caused by supply disruptions due to wars, sharp economic global slowdown led by the US, uncertainty of Indian elections, a slowdown in Indian government spending, and a weak rural recovery are all risks that the market is focused on.

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Nifty valuations are still around their 10-year averages. So we would not call this as a very overvalued market, although there are pockets of overenthusiasm in the mid-cap and small-cap valuations.

Among the major risks, we believe a potential US hard landing is the key risk to watch out for; although that appears to be some time away. In the short term, the risk to the Indian market is the risk of overheating. As investors, it is time to keep emotions under control and carefully weigh risk-return prospects.

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.