Dec 17, 2024
• Mr. Trump’s policies likely to drive the US and Global economic landscape, influencing the market outlook for 2025
• India’s GDP numbers confirm slowing economic growth, however, a pick-up in government capex could revive economic activity in the coming quarters.
• Correction in the Indian equity market aligns with EPS downgrades, keeping valuations expensive.
• With economic activity bottoming out, we marginally reduce our underweight position in equities by marginally adding to equities.
Looming Uncertainty
The re-election of Mr. Trump and the Republican majority in the Senate and House indicate likely policy shifts that could lead to economic uncertainty. While the specifics and timelines of these proposed policies will become clearer after the administration takes office, Mr. Trump has expressed plans for tax cuts, higher tariffs, reduced immigration, and deregulation across various sectors. Each policy could impact the US and global economic outlook differently. Their combined effect, depending on their final form, is likely to drive market dynamics in 2025.
Mr. Trump’s proposed tariffs on all Chinese goods, coupled with a proposal to lower tariffs on other countries, could fuel inflation and dampen global demand. This may lead to higher interest rates and strengthen the US dollar. Early cabinet appointments suggest a likely hawkish stance on China, though it remains unclear whether tariff threats are intended as a negotiation tactic or a strategy to protect domestic industries and reduce the trade deficit. Similarly, immigration restrictions may shrink the labour force, curbing economic activity and driving inflation.
On the other hand, proposed tax cuts and deregulation could stimulate economic growth and boost US corporate earnings. However, without tariffs to offset revenue loss from tax cuts, the fiscal deficit could widen significantly, exacerbating the country’s fiscal challenges.
The Fed has signalled that it will not pre-emptively respond to Mr. Trump’s policies but will wait for their effects to become evident in economic data. Nevertheless, there is concern that these policies could stoke inflation, potentially leading to a slower and more delayed rate cut cycle than markets currently expect.
China is likely to be most affected by US policies. While its government may introduce stimulus measures to counter potential US tariffs, market expectations suggest the stimulus could fall short. Weakened domestic consumption from the real estate crisis has made the Chinese economy more export-dependent than in 2018. Additionally, China’s leadership aims to shift toward a technology-driven, domestically focused economy. As a result, China’s growth is likely to slow further in 2025.
Economic activity in the Eurozone remains subdued, weighed down by political uncertainty in France and Germany. While the ECB may continue cutting rates, Europe’s recovery is expected to remain slow.
Global Market Update
US equities continue their strong performance. Year-to-date, the S&P 500 is up more than 27%, building on 25%+ returns in 2023. The gap between US equities and the rest of the world continues to widen. Strong earnings, coupled with potential tax cuts and deregulation under Mr. Trump’s policies, have driven the rally. The rally has been led by technology, communication services, and financials. While technology and communication services could benefit from rate cuts, financials stand to gain from deregulation.
On the other hand, US Treasury yields have risen sharply following the election results. The bond market is concerned about inflation and its potential impact on Fed policy.
Both global equity and bond markets may remain volatile as Mr. Trump’s policies become clearer once the new administration takes office.
Source: Bloomberg, Sanctum Wealth
India Macro Update
India’s GDP growth slowed to 5.4% y/y in Q2FY25, well below expectations and declining from 6.7% in the previous quarter. GVA growth also softened to 5.6%. While some slowdown in GDP growth was anticipated based on high- frequency indicators, the extent of moderation exceeded expectations.
GDP growth moderated in Q2 FY25
Source: Bloomberg, Sanctum Wealth
The industrial sector, particularly manufacturing and mining, drove the slowdown, as reflected in high-frequency indicators such as IIP and core indices. Government capex, a key contributor to GDP growth, moderated in H1, with central and state capex declining by 15% and 11%, respectively. Consumption growth slowed to 6%, with rural demand showing signs of recovery while urban demand weakened. High food inflation and stagnant real wage growth appear to have weighed on overall consumption.
Early signs of increased government capex are evident, potentially contributing to GDP growth in the second half of the fiscal year. High-frequency indicators, including GST collections, e-way bill generation, goods exports, and auto sales, point to a rebound in economic activity in October and November. A strong Rabi season is likely to benefit agriculture and boost rural demand. However, growth figures may appear muted due to the higher base effect from last year, despite the anticipated improvement in activity.
In its December policy meeting, the MPC kept rates unchanged at 6.5%, although two independent members voted for a 25bps cut. The stance remained neutral, and the CRR was reduced by 50bps to ease liquidity. The FY25 growth forecast was lowered to 6.6% (from 7.2%), while the inflation forecast was raised to 4.8% (from 4.5%), reflecting higher Q3 projections.
Source: RBI, MPC documents
The policy was in line with market expectations amid geopolitical uncertainties, currency pressures, and high inflation. The RBI appears to be awaiting clarity on U.S. policy direction after Mr. Trump assumes office, further GDP data and the impact of Rabi crop sowing on inflation. Markets anticipate a rate cut in February 2025, but the easing cycle is expected to remain limited.
India Market Update
Indian equities rebounded in November after an initial correction, partly driven by BJP’s favourable results in the Maharashtra elections. Broader indices are down 5-7% from their September peaks, recovering from a mid-November low of ~10%. However, some sectors saw more pronounced corrections. Several consumption-focused stocks like Asian Paints, Avenue Supermarts, Colgate, Tata Consumer products and PSU stocks like BHEL, IRFC, Rail Vikas Nigam that surged earlier this year have declined more than 20% from their peaks. Despite these declines, valuations remain elevated.
Source: Bloomberg, Sanctum Wealth
Tactical Asset Allocation | Quarterly Asset Pairs Review
Strategic asset allocation sets long-term targets aligned with an investor’s goals and risk tolerance, while tactical asset allocation adjusts portfolios based on market opportunities. At Sanctum, our tactical strategies are guided by our proprietary asset-pair model, which focuses on key fundamentals and filters out market noise. Our latest asset-pair scores show minimal changes. We maintain an underweight position in equities, favouring large caps over midcaps. In fixed income, we lean toward government bonds and hold a neutral stance on duration. We expect modest INR weakness against the USD and foresee a moderation in gold’s strength, though we maintain a long-term preference for gold.
Equities vs Bonds
Valuations expensive, macro and earnings likely to improve in coming quarters.
Corporate earnings for the quarter ended September 2024 fell short of expectations, with more companies missing than beating estimates. Nifty sales growth remained in single digits for the sixth consecutive quarters, slowing further to 4% in the latest quarter. EBITDA margins moderated, resulting in mid-single-digit growth in both EBITDA and PAT for the second straight quarter. While markets expect earnings growth to improve over the next two quarters and accelerate significantly in FY26, Nifty EPS estimates for FY25E were revised downward by 1.4% and for FY26E by 2.2%, with some adjustments already priced in before the earnings season began.
Nifty PAT growth in single digit again
More misses than beats in Q2 FY25
Source: Bloomberg, Sanctum Wealth
Indian equities, particularly mid and small caps, were trading well above historical valuation levels before the correction in October. With only 5-7% correction from peak levels and downward EPS revisions, forward valuations have not meaningfully adjusted. Except for a few sectors like banks most of the market continues to trade at a premium to historic valuations.
Indian equities expensive
DIIs buying more than offsetting FII selling
Source: Bloomberg, Sanctum Wealth
Foreign investors remained net sellers in November, adding outflows of USD 2.2bn to the sharp withdrawals seen in October. Year-to-date, FIIs have sold USD 2.1bn as of November-end. In contrast, domestic institutional investors purchased USD 5.3bn worth of Indian equities in November and USD 21.4bn year-to-date. However, mutual fund flows moderated in November, and it remains uncertain if this trend will continue.
One of the key reasons for our underweight stance on equities after the last asset pair update was the slowing economic activity reflected in high-frequency indicators such as IIP and core industry growth. The disappointing GDP growth further validated this view. While government spending is picking up and economic activity is improving, it may take 1-2 quarters for these developments to be reflected in corporate earnings.
Global factors, including potential repercussions of Mr. Trump’s proposed policies, such as higher tariffs on China and other countries, could keep global markets — including Indian equities — volatile. Overall, while we remain underweight on equities, we are gradually reducing our underweight position.
Large-caps vs Mid-caps
Midcaps more expensive
During the recent correction, mid and small caps declined as much as large caps. These segments also reported earnings misses, preserving the valuation gap with large caps. Inflows into mid and small-cap mutual funds remain strong, potentially supporting these segments. However, many investors in this space have not experienced prolonged drawdowns, making it critical to observe their behaviour if the market enters a longer correction phase.
Midcaps more expensive than large caps
Source: Bloomberg, Sanctum Wealth
Some mid and small-cap stocks have experienced deeper corrections than the broader index, potentially creating selective investment opportunities for active managers. However, we recommend that investors maintain an underweight position in mid and small caps while staying overweight in large caps.
Fixed Income | Corporate vs Government | Short-term vs Long-term
Supply-demand dynamics supportive of duration
Credit spreads between high-quality corporate bonds and government bonds remain low as credit demand continues to outpace deposit growth for banks. Meanwhile, corporates have deleveraged, and balance sheets are healthy, as reflected in a higher upgrades-to-downgrades ratio. Despite the strong credit environment, we remain selective in the high-yield segment, given the significant inflow of funds chasing this space.
FII flows into Indian bonds strong, except Oct’24
Credit rating trends remain strong
Source: Bloomberg, Sanctum Wealth
As we have highlighted earlier, we expect the RBI rate-cut cycle to be shallow, however, bond yields have moved up slightly in the last few weeks. Further, FII inflows into Indian bonds are likely to resume with graded index inclusion. While we are not looking to add further duration in our client portfolios, those that missed out could look to take some duration exposure at current levels.
Gold vs Cash
Gold as an insurance
Gold has been one of the top-performing asset classes this year, delivering over 20% returns in INR terms, driven by strong demand from global central banks, despite a 7% price drop following the import duty cut. However, this sharp rally has made gold expensive relative to other commodities. Additionally, moderating US inflation, low equity volatility, and a strong US dollar have pressured gold prices. Nonetheless, demand from gold ETFs and an increase in open contracts continue to support the metal. The recent moderation in prices could also encourage central banks to resume their purchases..
While the fundamentals for gold are mixed, we remain overweight on gold as a hedge against potential inflation or geopolitical tensions, particularly under Mr. Trump’s presidency. Furthermore, we believe the opportunity cost of holding gold is limited, given the lack of expectations for strong returns from equities or debt.
Recent US dollar strength has weighed on gold price
Source: Bloomberg, Sanctum Wealth
Net contracts have supported gold prices
Source: Bloomberg, Sanctum Wealth
INR vs USD
Depreciation bias could continue amid dollar strength
Recent dollar strength has put pressure on the INR, although it has outperformed most emerging market currencies. Despite some depreciation year-to-date, the INR remains overvalued based on Real Effective Exchange Rate (REER). Additionally, the dollar’s strength could persist, particularly if Mr. Trump’s policies driver US inflation higher and the Fed responds with fewer rate cuts than expected. A reversal of capital flows towards the US from emerging markets, driven by potential corporate tax cuts, could further weigh on the INR.
That said, several factors support the INR, including large FX reserves, range-bound crude oil prices, a stable current account deficit, and a balanced payments position. Additionally, passive foreign inflows into Indian debt are expected to resume with gradual index inclusion. While foreign inflows into equities are harder to predict, FII holdings in Indian equities are at multi-year lows, suggesting potential for some reversal. Moreover, the RBI has been actively intervening to curb INR volatility and, given its substantial FX reserves, may continue to do so.
Overall, while the INR could remain under pressure if the USD strengthens, it is likely to outperform other emerging market currencies.
FX reserves in favour of INR
Dollar strength can weigh on INR
Source: Bloomberg, Sanctum Wealth
Sanctum Multi-Asset Portfolios
We manage our multi-asset portfolios known as SMAPs, which reflect our tactical asset allocation decisions across three profiles: Shield (conservative), Enhancement (balanced), and Generation (aggressive).
In August, we underweighted equities and gradually increased this underweight to nearly 10% in our most aggressive strategy, Generation, anticipating weaker earnings growth and signs of an economic slowdown. While we maintain an underweight position in equities, we plan to reduce this to around 7.5% and allocate some of the available cash to equities amid improving economic activity. We remain overweight on gold, as it continues to act as a strong hedge against global uncertainties, with limited opportunity cost for holding it.
Private banks continue to trade at valuations below historical averages. Their earnings results were largely in line with expectations and better than the broader market, which is why they did not decline as much during the recent correction. We plan to add to private banks through equities rather than increasing beta currently.
Due to our underweight stance on equities during the correction, all our portfolios have outperformed during this period. Here is an update on the performance of our three multi-asset portfolio strategies:
Performance is calculated using Time Weighted Returns, net of fees and expenses. Returns over one year are compounded annually; returns for less than one year are absolute. Please note that SEBI does not verify the performance information provided above. Please note that past performance is not a guarantee of future performance.
NSE Multi Asset Index 2 composition is 50% Nifty 500, 20% Nifty 50 Arbitrage, 20% Nifty Medium Duration Debt Index, 10% Nifty REITs and InVITs