Nov 5, 2024
“People usually expect the future to be like the past and underestimate the potential for change” – Howard Marks
The Indian markets continued to touch new highs in the quarter with large caps leading the way. Markets continued to climb on the wall of worries. The Nifty and Sensex clocked 7.5% gains during the quarter while the small and mid-cap indices jumped by 4.7% and 7.92%, respectively.
The Nifty has now recorded eight straight years of positive returns for the first time in its history and, as we write, the Nifty is in positive territory for the ninth year as well. The primary driver behind the robust rally over the past four years has been earnings growth of over 20%, supported by strong domestic liquidity.
The big question on every investor’s mind: What should we expect next from the market?
Incrementally, the overall uncertainty in the markets has gone up. Let’s look at certain factors that drive the markets.
Earnings and Corporate tax collections
While Nifty50 as a composite was seeing earnings deceleration in last couple of quarters, Q1FY25 was the first one for the broader markets in recent times. Earnings have remained subdued across the spectrum. We anticipate normalised earnings growth in FY25, in contrast to prior years, as margin benefits diminish and topline volumes fail to fully offset margin losses. This trend is mirrored in corporate tax collection, which have declined by 6% YoY in the current fiscal, a first since the COVID-19 pandemic.
Source: Avendus Spark
Government capex spend (Centre and State)
One of the key drivers post-covid for the corporate earnings has been the capex allocation towards various projects by the governments. Both the centre and state governments’ allocation towards the capital expenditure is currently lagging the previous year by a distant margin. Central capex expenditure is down by ~19%, and spending among large states has decreased by about 17% in the first 4-5 months of this fiscal year. State spending trends are increasingly concerning, as a shift toward welfare schemes and subsidies diverts funds from long-term capital expenditure.
Source: Avendus Spark
Private sector capex expenditure
Even though the new investment grew by >67% YoY for the Sept’24 quarter, the cumulative number for the current fiscal is ~30% below. New investments are primarily concentrated in sectors such as manufacturing, electricity, construction, real estate, and the services industry.
Source: Avendus Spark
Flows and Valuation
Regarding capital flows, we are seeing one of the largest domestic investor inflows in the past five years, juxtaposed against relatively modest contributions from Foreign Institutional Investors (FIIs). To put things in perspective, DIIs have invested ~$49bn (~INR 4 lac crores) in CY24YTD of which a significant part of allocation has been towards mid and small caps.
This is reflected in the performance of portfolios. The higher the allocation to mid and small caps the better has been the portfolio performance in last one year. This could change incrementally as the earnings have started to see weakness across the board. Markets are fundamentally driven by earnings, and if earnings momentum does not hold, liquidity may shift to a new theme/sector.
Source: Bloomberg
Source: Axis Capital
At this juncture, valuations are higher than historical levels across sectors. In certain pockets there are clear signs of overvaluation. While we remain positive on the longer-term potential of the Indian markets, in the short term, we remain cautious due to elevated valuations, weakening earnings growth, overall reduction in government capex spends and increasing geopolitical risks.
Portfolio Positioning
As the capex theme subsides and more government resources are routed to welfare schemes, there could be a shift towards consumption as a theme – that has not seen a broad-based participation because of dwindling demand – especially in low-end categories.
Consumption needs to be viewed through a different lens, as consumer preferences and behaviour have evolved over time. This trend shall accelerate as we see our per-capita income cross $2500. We believe given India’s under-penetration across categories in the consumer space, the room for growth is significant, especially in the low-end discretionary space. For example, refrigerators, a basic household appliance, have a 40% penetration rate in Indian households, in contrast to nearly 100% in most major economies. The under-penetration is higher in other categories like washing machine, ACs and kitchen appliances.
As mentioned in our last note we have been increasing weights in telecom, auto ancillaries, affordable housing finance and consumer staples in both the strategies while holding up positions in private banks at the top.
Recently, we included Epack Durables, a leading Original Design Manufacturer (ODM) of room air conditioners in India, to our portfolio. The recently listed company is now a part of Titans portfolio, and we are raising allocation because we think it’s a structural long-term growth pick and is undervalued compared to its direct peers.
The company will benefit from the industry tailwind as the room-AC category has witnessed 30-40% growth in the 2024 season to touch a record 14 million units. The market is further expected to grow at double digits for a prolonged period led by hotter summers, higher disposable incomes, rising urbanisation, and easy financing options. The company is also diversifying its product portfolio by expanding into the assembly of washing machines and air coolers. The company has doubled its revenue and quadrupled its profits in the last three years and the growth momentum should continue as it scales up.
Similarly, we have exited CIE Automotive India which had both global and domestic exposure and replaced it with ASK Automotive, which is a manufacturer of anti-lock braking systems (ABS) for domestic two-wheelers. The company’s kit value in electric two-wheelers is 2x that of an internal combustion engine (ICE), due to its aluminium light-weighting solutions. We expect the company to post robust PAT CAGR led by double-digit sales growth and higher margins in newer product segments.
Source: Ace Equity, Sanctum Wealth Research
Our portfolios stance at this juncture would be of downside protection as we see near-term headwinds in the market led by slowing earnings amid stocks priced to perfection. We remain bullish on structural themes like manufacturing and China+1 export opportunities, affordable housing and related proxies, low end consumer discretionary, healthcare and financialization. While we are also positive on the power sector, we currently don’t have any direct exposure to it.
We will continue navigating this volatile environment with a balanced approach, combining structural investments with tactical, short-term allocations to defensive assets.
Summing up
We believe that our focus on structural themes will help us deliver higher risk-adjusted return in the long-run. As the momentum rally subsides, and focus gets back to performance and fundamentals, quality and structural themes should lead the markets going forward. It has already started playing out in a limited way and we believe that the market will increasingly look at business delivery and reward stock prices accordingly. We always build our portfolios looking at business delivery and believe that the short-term pain is the price we pay for sticking with quality businesses over the long run.
The recent performance lag in our portfolios is narrowing, and as focus shifts back to fundamentals and quality, we anticipate further improvement. Here is how our flagship portfolios have fared over the different time frames.
Portfolio Performance
