Can the silver linings dominate the clouds on the economic horizon?

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Sliver moving clouds

The Nobel laureate economist George Stigler once famously said: “abnormal is when everything is normal.” More often than not, the economic and market scenario will be characterized by a mix of tailwinds and headwinds.

When the tailwinds are strong, stock markets rally; when the headwinds are strong, stock markets turn bearish.

When tailwinds and headwinds are balanced, markets consolidate waiting for clearer signals. What is the current scenario and where are the markets headed?

Investors must be a happy lot. The first half of FY24, from April 1st to September 30th, has delivered good returns: Nifty has delivered 13 percent and the broader market has outperformed with Nifty Midcap 100 delivering 35 percent and Nifty Smallcap 100 delivering 42 percent return.

Can this outperformance continue? Should investors be cautious? Where is safety in the market now?

Globally markets are highly correlated. The mother market US sets the trend and others follow. So, the US economic scenario and market trend are hugely important.

The S&P 500 is up by 13 percent YTD (as of 30th September 2023) triggering a mild global rally this year. This global rally has been driven mainly by the US economy’s soft-landing narrative.

In India, the rally has been supported by the resilience of the domestic economy. The weakening Chinese dragon emboldened the India bulls triggering impressive inflows – both foreign and domestic – into the market.

The ‘Sell China, Buy India’ strategy played a major role in the rally which lifted the Nifty from the March lows to above 22000 in September. But now the headwinds from the US bond markets are impacting FII inflows and market sentiments.

How long will this trend last? Rising dollar and US bond yields pose near-term threats

In early October the dollar index spiked to 107 and the US 10-year bond yield is now hovering around 4.83 percent. This is a perfect setting for FPIs to sell.

The rising dollar and spiking US bond yields scenario had forced the FPIs to sell in September after four months of sustained buying in the market.

If the dollar index and US bond yields sustain at these levels, FPIs will continue to sell, impacting market sentiments. Of course, DIIs and retail can counterbalance the FPI selling with aggressive buying; but that requires valuation comfort.

Are the valuations attractive?

Valuations are fair, but not compelling. The last 10-year average Nifty PE multiple has been 17.5. India is the fastest growing large economy in the world now and there is a near consensus that India has the best growth story among the large economies of the world.

So, India rightly deserves a higher PE multiple than peers. The fact is that the market has already partly baked this optimism in the valuations. At 19500, the Nifty is trading at 20 times FY 24 estimated earnings and at 18.5 times estimated FY25 earnings. In brief, the valuations are fair, but not compelling in the short run.

There is no valuation comfort in the broader market; now safety is in large-caps.

The US market holds the key

It is the high inflation and the ‘higher for longer’ expected rate regime in the US that is pushing the dollar and the bond yields higher. If this trend sustains, the headwinds for equity markets will remain strong.

On the contrary, if the US inflation declines and the Fed pauses and turns less hawkish the dollar index and the US bond yields will head south triggering a rally in equity markets. So, watch out for the US macros.

Indian economy is resilient

India’s GDP is expected to grow at 6.5 percent this year. The leading indicators suggest resilience. Direct tax collections are up by 23.5 percent during April 1st to September 16th. GST collections are strong with 11 percent uptick in H1 FY24.

The recovery of monsoon in September indicates a normal monsoon. Most segments of the economy are doing well. Massive government expenditure on infrastructure and defense has boosted the prospects for cement, steel and power.

Private capex has boosted the prospects for the capital goods segment. Luxury consumption is robust. Real estate, hotels and automobiles are on strong wicket. Impressive credit growth augurs well for financials. On the flip side, IT is struggling under weak global growth.

On the external front, the biggest threat is a plausible real estate crash in China and its impact on global growth, which will have repercussions on global markets, too.

The macro trends from the US and Chinese economies will shape the global market trends in the short-term. Long-term investors can ignore these short-term issues and continue to invest in the India Growth Story.

First published in The Economic Times

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