Jefferies' Mahesh Nandurkar explains why the market correction might be near its end

Mahesh Nandurkar believes Indian markets are positioned to outperform developed markets, particularly as the US faces economic headwinds

After five straight months of seeing red, the Indian markets might be staring at the fag end of its correction cycle, believes Mahesh Nandurkar, MD & Head of Research at Jefferies India. In a conversation with CNBC TV-18, he asserts that the steep correction has brought valuations below historical levels across several pockets, with early signs of economic recovery setting the stage for renewed stability.

Nandurkar highlights three key reasons for his optimism, a rebound in government spending, easing regulatory pressures on banks, and a shift in global market dynamics that could favor emerging markets like India. With improving domestic fundamentals and a potential inflection point in global market trends, he believes India could be poised for a period of relative outperformance.

Edited excerpts from the interview:

Let’s start with the big picture. The Nifty has given up all of last week’s gains, and midcaps have been hit even harder. Given the ongoing global uncertainties, including Trump's tariff threats, how do you see things shaping up for India?

Mahesh: I believe the much-needed market correction is now behind us. This correction was necessary because valuations had moved far ahead of fundamentals. While the fundamentals were strong before, they were never as great as market sentiment suggested. Similarly, today’s fundamentals aren’t as bad as current sentiment may indicate. I see us somewhere in between.

Markets have now adjusted to a more realistic level—both in terms of valuations and relative performance. Broad market valuations are back to their 10-year averages, and even at an individual stock level, out of the 200+ stocks we cover, around 100 are trading at or below their last 10-year average.

You’ve made a bold call, saying this five-month-long correction is likely over. What gives you that confidence?

Mahesh: Valuations are a key factor. As I mentioned, they have come down to long-term averages. But beyond that, I see improvements in fundamentals.

Two major factors weighed on the economy in the first half of FY25. Firstly, government spending.  In H1, government expenditure (excluding interest payments) declined by about 2-3% year-on-year. However, in H2, it's projected to rise 14-15% YoY. Since this spending accounts for about 10% of GDP, this swing alone contributes around 150 basis points to GDP growth.

Secondly, over the last year, credit growth slowed from 16-17% to about 10-11%, largely due to regulatory pressures on banks. I believe most of those pressures are now behind us. The RBI has turned more constructive, focusing on improving liquidity. Credit and deposit growth have likely bottomed out.

So, in summary, you’re optimistic because of valuation resets, improved government spending, and an easing of regulatory pressures on banks?

Mahesh: Exactly. These factors are already starting to reflect in high-frequency data, which reinforces my view that we are at the tail end of the correction.

You mentioned the domestic market turning slightly positive. What’s your take on the global setup?

Mahesh: The global setup has become very unpredictable. We are seeing new announcements and data points from the US almost every day. However, if we look at broader fundamental indicators, things have changed directionally.

Could you elaborate on that?

Mahesh: Around September last year, after the US election results, the U.S. dollar strengthened significantly, and there was optimism about economic growth. But by mid-to-late January, things started peaking out. The DXY index, which measures dollar strength, has dropped from 110 to 103 in the last two months. The 10-year US yields are also down by 40-45 basis points, and market expectations for Fed rate cuts have gone from 20 basis points for the year to 75 basis points. All these factors indicate a weakening economic outlook for the U.S.

The US equity market has been a massive driver of global markets. If it peaks out, does this mean trouble for markets like India?

Mahesh: Traditionally, when the US market struggles, other markets follow. But this time, emerging markets, including India, might perform better. For years, investors stayed within the US because their home market was doing well. Now that the US is showing weakness, investors might look for better opportunities elsewhere.

So, are we seeing a shift in market patterns?

Mahesh: Yes, and it would be a significant shift. The US market's weight in global indices has gone from 40% in 2010 to around 65-67% recently. If it starts declining while emerging markets perform well, it would be a major break from a 15-year trend.

Does this mean a bullish outlook for India?

Mahesh: I wouldn’t say a raging bull run is coming, but relatively speaking, emerging markets should do better. We are already seeing improved fund flows into European and Asian markets, particularly Chinese equity funds.

Let’s talk about asset classes—specifically, Nifty and gold. What does the Nifty-to-gold ratio indicate?

Mahesh: Currently, the Nifty-to-gold ratio is around 2.75, meaning you need 2.75 grams of gold to buy one Nifty. Historically, this ratio has ranged from around 2 during extreme downturns (like COVID) to around 5 at its peak.

What does that mean for Nifty’s future performance?

Mahesh: Historically, when the Nifty-to-gold ratio drops to around 2.5-2.75, it often signals a favorable entry point for Nifty. More often than not, the index performs well a year after reaching this level. While there may still be some downside, we are gradually reaching that sweet spot.

How does India’s market capitalization compare to its gold holdings?

Mahesh: India’s total gold stock is around $3 trillion, while the total market capitalization is about $4 trillion. This ratio is quite balanced, whereas globally, gold holdings tend to be much smaller compared to stock markets.

So, is the Nifty-to-gold ratio turning favourable?

Mahesh: Yes, it appears to be reaching a historically favourable level, which suggests potential upside for Nifty in the medium to long term.

History suggests that when you need around 2.5 to 2.75 grams of gold to buy the Nifty, the following year has been positive. Do you think we are reaching that point? Is this something you track?

Mahesh: That’s an interesting analysis. To be honest, I hadn’t looked at it this way before, but it does give me another reason to be optimistic. In India, this is particularly relevant because the total gold stock is around $3 trillion, while the total market capitalisation is about $4 trillion. In comparison, the percentage of gold holding versus market capitalisation in the US is much lower, likely in the mid-single digits.

You’ve been quite constructive on the market. Which sectors should investors focus on while building their portfolios?

Mahesh: The best risk-reward sector right now is lenders—banks and lending NBFCs. This sector currently has valuations one standard deviation below the averages, making it the only sector in India with such a discount. Additionally, the RBI appears to be constructive on improving liquidity, which is excellent news for the banking sector and NBFCs. The biggest challenge over the past year has been weak deposit growth and pressure on loan-to-deposit ratios (LDRs), leading to a forced reduction in credit growth. However, this issue seems to be easing.

Has the recent derivatives issue with a large lender concerned you? There are reports that regulators may conduct broader checks across the sector.

Mahesh: It’s a possibility, but I don’t see it as a systemic issue. It’s not something that will impact the entire sector. As deposit growth improves, credit growth will follow, easing concerns about asset quality. Overall, from a risk-reward perspective, banking remains a strong sector to own.

You’ve been cautious on IT. Is that due to valuations or global concerns?

Mahesh: Both. IT valuations have been on the higher side—one standard deviation above the averages. Investors were willing to pay a premium when the growth outlook was strong, and the dollar was favorable. However, with a weaker growth outlook in the US and the fading currency tailwind, it’s difficult to justify paying a 20-25% premium. Even after recent corrections, the sector is still trading at a 15-18% premium, which I find hard to justify given better opportunities elsewhere.

What’s your view on metals and mining? The sector has seen a pullback, but some stocks have outperformed.

Mahesh: While global demand, especially in the US, appears weak, we are seeing improvements in China and Europe. The Chinese property market is showing signs of bottoming out, which is a crucial factor for global steel demand. Additionally, potential safeguard duties could provide a boost. If implemented, these could lead to 20-25% EPS and EBITDA upgrades, making the sector attractive.

Are there other sectors you are optimistic about?

Mahesh: Discretionary consumption, including travel, remains strong. We also like autos and real estate. Real estate is a great long-term story. While we were cautious around election time, the budget has made us more constructive again. The sector has seen a significant correction in the past few months despite strong fundamentals—solid pre-sales numbers and healthy balance sheets. Interestingly, some real estate promoters are now buying back stock, indicating confidence in the sector.

Could autos, real estate, and financials lead the next bull market?

Mahesh: Possibly. I’d also add power to the mix. Power demand was weak in the first half of the year, but we are now seeing a recovery. I’d prefer playing the power play directly through generation companies.