Unleashing the bulls: How the stock market achieved unprecedented record levels

Market Volatility and Exogenous Factors:
Market volatility primarily stemmed from exogenous factors. Global monetary and fiscal tightening measures were implemented across countries (with few exceptions) to manage persistent inflation. The shocks caused by the Russia-Ukraine war and China’s Covid restrictions also contributed to volatility. Furthermore, the global economy slowed due to aggressive rate hikes undertaken by central banks in advanced economies to control anticipated transitory inflation.

These circumstances led to unbiased selling in emerging markets as investors sought safer assets with higher yields, further exacerbated by the strengthening of the US Dollar. The collective occurrence of these events elevated the geoeconomic risk landscape to structurally higher levels.

Emerging Opportunities for India:
Fortunately, emerging economies like India, with comparatively stronger fundamentals, have experienced a shift from headwinds to tailwinds, resulting in a fortunate and unexpected turn of events. Inflation has sharply declined at the retail level and is deflating at the wholesale level. Domestic interest rates are likely at their peak, while central banks in advanced nations are considering further hikes, potentially sacrificing growth. Commodity prices have cooled and stabilized from their peaks, and the US Dollar is expected to weaken relative to other currencies. Bond yields have fallen amid a stable monetary policy outlook.

Driving Factors for Indian Equities:

Domestic stocks are reaching new highs due to a stable macro environment, a growing economy, and healthy corporate profits. These factors have attracted substantial institutional investor inflows. Over the last decade, the Indian economy has undergone transformations through the formalization of the economy, supply-side policy reforms, infrastructure development emphasis, the implementation of the Real Estate (Regulation and Development) Act, digitization of social transfers, and the Insolvency and Bankruptcy Code. These developments have made India an attractive investment destination for foreign investors. Strong domestic demand, favourable government policies, robust business and consumer balance sheets, and structural variables such as Production-Linked Incentives (PLIs) and Free Trade Agreements (FTAs) are driving India’s GDP growth, making it the fastest-growing major economy.

Importance of PLI Scheme and FTAs:
The PLI scheme plays a crucial role in India’s development by stimulating capital expenditure, manufacturing, and exports, while simultaneously reducing dependence on imports. Additionally, signing FTAs with significant economies will act as a catalyst to increase India’s contribution to global exports, which currently stands at only ~2%. Emphasizing infrastructure development will create a multiplier effect, benefiting a wide range of industries, as the government continues its capital expenditure supported by robust revenues and asset monetization. These structural dynamics have paved the way for multi-decadal growth opportunities within the domestic economy, driven by strong domestic demand and export prospects. Although short-term weakness in global demand poses challenges for exports, steady growth in exports is expected over time.

Leveraging Structural Shifts and Domestic Megatrends:
Given the limited opportunities on a global scale, inflows into emerging economies, including India, were inevitable. Listed corporates in India have reported healthy earnings, with the Banking, Financial Services, and Insurance (BFSI) sector contributing significantly, followed by the automobile industry. This resilience has fueled investor optimism, as macroeconomic indicators reflect a growing economy and moderating inflation.

Focus on Small and Micro Caps:
Considering the advancing trend of economic growth and expected rate cuts in the last quarter of FY24, small-cap and micro-cap stocks are favourably positioned in the current bull cycle. These stocks benefit from disproportionately higher exposure to the industrial sector, discretionary spending, and niche segments that align with the ongoing economic upcycle. Analysis of earnings yield and historical values indicate that small-cap stocks are relatively undervalued. Consequently, strategically allocating investments to select small-cap stocks with solid fundamentals and growth prospects offers attractive risk-reward opportunities that are likely to outperform over the next two to three years.

Indian equities have surged to record levels driven by a broad-based investment cycle and a progressing trend of economic growth. Despite global market volatility caused by exogenous factors, India’s favourable fundamentals and transformative policies have turned headwinds into tailwinds. As we progress into a rate-cut cycle, the intrinsic value of the business will be repriced positively which will be reflected in the multiple expansion of equities as a class, with Small and Mid-Cap stocks getting the most benefit of the liquidity flow. In conclusion, the Indian economy’s resilience, driven by domestic demand, export opportunities, and government initiatives, has attracted significant institutional investor inflows. As the economy progresses, Small and Mid Caps present promising investment prospects due to their exposure to industrial sectors, discretionary spending, and niche segments.

(The authors of the article are Prabhat Ranjan and Vijay Chauhan, co-fund managers, Right Horizons, PMS)

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