Fed’s change in stance will trigger a solid rally in largecaps: Saurabh Mukherjea

Since there is no underlying basis for them not to signal a dovish stance, they have gone ahead and done so, plus I suspect they have some underlying data on US consumer demand, which suggests that US consumer demand has cooled off along with global commodity prices.

In a conversation with Moneycontrol, Saurabh Mukherjea, founder and CIO, Marcellus Investment Managers, talks about what the latest Federal Reserve commentary on three quarter-point cuts to its benchmark interest rate in 2024 could mean for the Indian markets and increased FII inflow in the coming days. Edited excerpts of the interview:

What do you take away from the US Fed’s change in stance? 

They must be seeing the underlying data that you and I don't have. But even the data that the public is seeing suggests that inflation is down to 2-3 percent across the Western world. More importantly, it suggests no buoyancy at all in crude or mineral prices. Three months into a Middle East war, crude is down from $90 to $70 and you have the Chinese economy deflating quarter upon quarter. I think that combination has given them the clarity of thought and courage to say that next year we will cut.

Since there is no underlying basis for them not to signal a dovish stance, they have gone ahead and done so, plus I suspect they have some underlying data on US consumer demand, which suggests that US consumer demand has cooled off along with global commodity prices.

Also read: US Fed keeps key interest rate unchanged, foresees three rate cuts in 2024

You had spoken about money being ready to enter India soon. Is there a threshold US rate that global funds will wait for to head back into risk assets?  

I don't think the money will wait for the rates to come down. From March/ April this year, the trickle started once foreign investors had visibility that the rupee is not going to give way to the dollar. We fell from Rs 72 to the dollar in January '22 to Rs 82 to the dollar in February '23. And then once the American banks started going bust, we softened marginally from Rs 82 to Rs 83 to the dollar.

At this point, I think the foreign investor will have a lot of visibility that further softening of the rupee is highly unlikely given that the Fed has given its signal, there is healthy economic growth in India, and there is political clarity.  This should lead to the next calendar year being a $20 to $30 billion foreign inflow (equities) kind of year. A good year for India is $40 billion dollars. An average year for India is $20 to $30 billion. I think we're looking at a $20 to $30 billion inflow this year, from an FII perspective.

Also read: Fed Rate cut expectations by March are ‘Optimistic’, Rajan says

So, there is a threshold rate that will set the stage for big flows?  

Once US 10-year bond yields start moving towards the 4-percent mark is when "cheap money" starts flowing from an equity investment perspective. The spine of the global financial system is cheap money. In the last 20 days or so, the US 10-year bond yield has come off sharply and US treasuries have come off every more sharply. So you are getting a blistering rally in US treasuries and you are getting a pretty solid rally in US 10-year bonds. That's the real signal that the equity investors pivot on. If long-term money is getting cheaper, they know they can afford to go to emerging world and take long term bets on high quality companies.

Follow our market blog for live updates

Is there a case for stock prices seeing a big rally in the coming year?  

I reckon that this will trigger a solid rally in largecaps. What we have seen over the past two years, is the strongest smallcap (relative to largecap) rally we have seen in India in 20 years. I've never seen anything like this. This is quite extraordinary.

There are a few things which have contributed to it, not least the sharpest rise in US interest rates in 40 years. If you push up US interest rates so sharply, naturally the foreigner pulls back and when foreigner pulled back, they left the domestic investors dominating the stock market. That's played a big role in smallcaps absolutely going through the roof. I'm not saying that it will completely reverse but the dominance of smallcaps in terms of our performance will moderate for the next couple of years.

Also read: Bulls all charged up as Fed signals rate cuts earlier than expected

If there is an election result that brings back a very strong government, that would lead to further financialisation domestically. In fact, financial flows from the domestic investor into the financial system three years ago was around $100 billion. My latest estimate is they're now doing $160-170 billion of domestic flows. This is not just stock market, it’s the financial system as a whole.

If there is an emphatic election result in May, then domestic number could push towards $200 billion. This is domestic financial flows. In that context, the $40 billion of foreign flows is material, but clearly the preeminent actor now in the financial system is the domestic investor. But the return of the foreign investment will bring some semblance of normality to the performance of largecap stocks relative to smallcap stocks.

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.