The Indian equity indices have experienced a correction of more than 10% in the last few months. A fall exceeding 10% is a correction, while a decline of over 20% is considered a bear market. The pressing question on everyone’s mind is: Have we reached the bottom of this downturn, or is there more to come?
No one, including the author of this article, can predict market movements with certainty. However, let’s examine a few factors contributing to this correction and assess how they might evolve.
FPI Selling
Foreign Portfolio Investors (FPIs) sold more than INR 1,000 billion worth of stocks in October. The selling pressure continued into November, with an additional INR 290 billion sold. Cumulatively, FPIs have sold over INR 2,500 billion in the secondary markets in 2024. Such sustained selling has significantly contributed to the downward trend in the market.
What is causing FPI to sell?
Several factors are influencing this sell-off:
- Global Economic Uncertainty: Concerns over global economic growth and geopolitical tensions are prompting investors to reduce exposure to emerging markets.
- Interest Rate Dynamics: Rising interest rates in developed economies make them more attractive, leading to capital outflows from emerging markets like India.
- Expensive Valuations in India: Indian stock markets have been on the expensive end of their long-term averages.
Domestic Investors Buying
While FPIs have been selling, domestic investors are investing in the Indian equity markets in large numbers. In the current year, they have invested over INR 4,000 billion. This ongoing inflow has helped cushion the market against a sharper decline due to FPI selling.
Will Domestic Investors Keep Buying?
Indian equities have historically provided strong returns over the last 10 and 20 years. As financial literacy improves and more investors become aware of these returns, the appetite for equity investment grows. Currently, equity constitutes only about 5% of the total assets of Indian households. This percentage will likely increase, leading to continued inflows into Indian equities. However, these inflows may fluctuate based on changes in risk appetite.
High Valuations
Indian equities have been the best-performing asset class in India and have outperformed many global markets over the past few decades. Indian entrepreneurs have created significant value, benefiting both their companies and investors.
After the recent pullback, the Indian large-cap index trades at around 21 times forward earnings. This raises the question: Are these valuations too high? In our view, the market is in a fair zone. Returns ranging from -10% to +15% over the next year seem reasonable. Any significant deviation from these returns will depend on how the Indian and global economies perform and how that influences the companies comprising the index.
Donald Trump – US president-elect
One of the big unknowns is how the US president-elect, Donald Trump, ‘s policy will impact geopolitics and economics in the next few years. Trump ran his election campaign on “Make America Great Again (MAGA).” Not only did he win the electoral votes and become the US president-elect, but he also won the popular vote in the US. This shows the strong support he got from the populace. Given his strong election victory, Trump is likely to move forward with his stated policies. All his appointments to the incoming administration are strong advocates of these policies.
We think that MAGA policies will create a lot of policy uncertainty for the rest of the world, including India. This is one of the reasons why FPI has been selling Indian equities and buttoning down its profits. The other reason is that Trump’s policies may be inflationary, which is raising US interest rates and, in turn, raising the cost of capital as well.
Equity markets don’t like uncertainty, and Trump’s election has caused a lot of uncertainty. No wonder the markets have sold off.
Earnings Miss
A more fundamental reason for markets sell-off after Q2 results is the weak performance of Indian companies in Q2. Indian companies had a very strong 20% cagr from 2020 to 2024. However, Q2 performance was below expectations. Q2 earnings performance cooled investors excitement about the future prospects of these companies and hence the valuation of many companies.
Is the earnings miss a temporary phenomenon?
We expect that earnings will pick up in H2 of FY 25. Multiple factors will drive better performance in H2:
- Excess rainfall above the Long-Term Average (LTA) means better water availability, which is generally good for crops and, hence, rural income. The benefit of this will be seen in the Rabi crop.
- Low leverage on the corporate balance sheet should allow them to incur capital expenditure as they see an opportunity.
- Government capex is running substantially behind its budget estimate. As government capex picks up, earnings growth will improve.
- The strong mandate of the current ruling party in various state elections is giving the government additional confidence to launch new welfare programs.
Conclusion
We feel that the recent pullback in Indian equities is giving long-term investors a fantastic opportunity to buy more of what they like the best. However, the path from here is not straight up. There will be various drawdowns along the way, and investors should account for them before they invest.
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