Navigating Uncertainty: The Outlook for Indian Equities in 2024
India Outlook
2023 was a great year for the Indian stock market. All key market indices are at their all-time highs now. Nifty 50 is up 20 per cent for the year. The midcaps and small caps outperformed with gains of 46 per cent and 55 per cent.
Despite the good performance of 2023, the valuation of Indian equities is still reasonable. Nifty 50 trades at a price-earnings multiple of 22.36, against the 5-yr median price-earnings multiple of 25.08. The yield differential between the Nifty50 earnings yield and the 10-year India government bond yield at 2.74 percent is closer to the 5-year median differential of 2.70 percent.
The general outlook for Indian equities in 2024 seems optimistic. Almost everyone expects a classic bull phase in 2024 for Indian equities. The end of the rate hike cycle by global central banks, anticipated rate cuts in 2024, receding inflation, strong macro stability, and better corporate earnings growth are cited as reasons for the positive outlook. BofA securities’ Nifty 50 target for 2024 is 23,000; ICICI Securities expects Nifty 50 to gain 15 percent or more in 2024; Morgan Stanley expects Indian equities to remain in positive territory for 2024.
I am not much worried about the market’s current valuation. What I am worried about is the quick pace of this year’s market gains. A significant portion of this year’s market gain happened over the last one and a half months. 68 percent of Nifty50’s gain this year occurred between 1 Nov. 2023 and 15 Dec. 2023. For Nifty Midcap 100 and Nifty Smallcap 100, the corresponding figures were 43 percent and 37 percent respectively. Such fast-paced and broad-based rallies usually happen either: 1) a recovery from a market bottom, or 2) at the last leg of a major bull market. Since all major indices are at all-time highs, this sure is not a market bottom, and is more likely to be the last leg of a major bull market.
Liquidity is an essential requirement for the proper functioning of the economy and markets. The economy functions through a series of transactions between individuals and entities, and to carry out these transactions we need money. Liquidity, in simple terms, is the money available in the system, and a straightforward way to measure liquidity in the system is the short-term yields. High short-term yields mean tight liquidity in the system, whereas low short-term yields mean ample liquidity in the system.
The origin of the current bull market was from the middle of 2020. Then, short-term yields averaged 3.34 percent and their yield differential with the long-term yields was 2.56 percent. The low short-term yields and reasonable yield differential signified ample liquidity in the system. In 2021, the average short-term yield was 3.81 percent, and the yield differential was 2.54 percent. However, by June 2022, the average short-term yield had risen to 5.70 percent and the yield differential reduced to 1.73 percent. By December 2022, the respective values were 6.65 percent and 0.68 percent. Now in December 2023, the short-term yields are 7.12 percent which signifies tight liquidity conditions. Moreover, the 10-year bond yields 7.22 percent currently. The yield differential of just 0.10 percent is a sign of elevated risk in the near-to-medium term.
India VIX – the volatility index – the measure of risk, fear, and uncertainty in the market is at the lowest level in five years. The median India VIX for 2023 at 11.973 is 30 percent lower than the 5-year median of 17.357. The present low value of India VIX indicates that market participants’ perception of risk and uncertainty in the current market is low. To put it another way, equity investors have more risk tolerance now. Equity investors maintaining a risk-tolerant attitude during a period of tight liquidity as signalled by bond yields is a cause for concern.
In the second half of 2007, just before the onset of the global financial crisis of 2008-2009, Nifty50 made a similar fast-paced and broad-based rally, gaining 38 percent in 4 months. The primary reason for the rally was the then Fed chair Ben Bernanke’s decision to cut interest rates. Now there was no Fed rate cut, just a change in stance towards reducing rates. Also, the rally had already begun before the change in stance. Maybe the current rally hasn’t peaked yet and has more steam left which is expected to play out in the coming months.
A high investor optimism; a market at an all-time high; a historically high valuation, a super-active IPO market, and a high retail participation in the markets; these are frequently observed patterns at the last leg of a bull market. Therefore, the current market should be viewed with scepticism because it has most of the above attributes at varying degrees.
Global Outlook
The Fed decided to keep fed fund rates unchanged at 5.25 – 5.50 per cent in its Dec 12 – 13 FOMC meeting. As inflation has moderated significantly this year, they have signalled that they are prepared to adjust their monetary policy stance if economic and financial system risks emerge. This means they are prepared to cut rates if the need arises. Markets cheered the Fed’s willingness to ease monetary policy as the latest decision was a marked U-turn from their earlier stance of raising rates to fight inflation even if that meant the economy fell into a recession. The Fed officials now anticipate three rate cuts in 2024.
S&P 500 closed at 4,707 points on Dec 13 and is inching closer to its all-time high of 4,766 points made almost two years back. Back home, the mood is more exuberant. Sensex has scaled the psychological mark of 70,000 this month, whereas the Nifty 50 index crossed both 20,000 and 21,000 levels this month. Both indices trade at all-time highs now.
In 2017 and 2018, the Fed raised interest rates from 0.50 to 2.50 per cent. However, due to adverse effects on the economy, the Fed reversed its policy and began cutting rates in 2019. Three consecutive rate cuts of 25 basis points each reduced the Fed funds rate to 1.75 per cent in 2019, but they didn’t boost the economy as intended.
The economy was reinvigorated only after interest rates were steeply cut to almost zero in 2020 in response to the COVID-19 pandemic crisis. The large asset purchase programs and fiscal stimulus measures also provided additional impetus to the economy. Additionally, the interest rate hikes in 2017-2018 were raised only by a cumulative 2 per cent over two years, while the hikes in 2022-2023 were much steeper and faster, a cumulative 5 per cent over a one-and-a-half-year period.
The recent events are reminiscent of the inflation-interest rate dynamics of the 1970s. Inflation rose to 12 per cent in 1974 due to the easy monetary policy of the early 1970s. The Fed then increased interest rates from 5 per cent to 14 per cent, which reduced inflation, though it remained elevated at around 6.00 per cent for almost two years. However, the hawkish Fed policy led to a recession in the US economy. The Fed responded by reducing interest rates back to 5 per cent, but this revived inflation which peaked at 14 per cent in 1980. It took two years and much harsher interest rate hikes (up to 20 per cent) to finally bring inflation under control. The 1970s were disastrous for the stock market as it lost 50 per cent in value between 1973 and 1975 and took a decade to regain the highs of 1973.
The range of possibilities for the market and economy in 2024 is wide-ranging. While many believe the US economy has dodged a recession in 2023, it may still materialize in 2024. Then, the Fed might reduce interest rates to stimulate or support the economy, but the resultant easy monetary policy could trigger the reemergence of inflation, which many believe to be subdued.
There are a few who believe the market rally of 2023 is a bear market rally. Seven mega-sized technology companies contributed to 130 per cent of the S&P 500’s return in the first 10 months of 2023. This means that if not for these seven stocks, the S&P 500 would have posted a decline in 2023. When the market bottomed out in 2022, these stocks had a 20 per cent share in the index, while now that has risen to 30 per cent. Investor’s flocking into market winners of the previous bull market is a too often evident pattern in a bear market rally. Market concentration in a small number of stocks is a serious cause for concern.
Final Thoughts
I am a sceptic and a contrarian. I believe these two qualities do provide some advantages in the stock market. It is not very advantageous to hold the same market outlook as everyone else, even if that view ends up being correct. This is because if everyone shares the same outlook, they would have already acted on it. Consequently, any expected gains would already be reflected in the price. Therefore, even if the expectation comes to fruition, the prices will not move much. However, if things turn out differently from the general expectations, that will significantly reflect on the market prices.
I poured a spoonful of doubt on the generally optimistic outlook for 2024, but that does not mean the prospect for the market and economy next year is dark and gloomy. The global economy has been operating under an ultra-low interest rate environment for a significant portion of the last 15 years. Such long periods of low interest rates could have formed asset bubbles in some corners of the financial system. There is a risk that in 2024, these bubbles may become conspicuous and lead to a crisis in the global economy and the financial system. But that’s just one among many possibilities of how markets and the economy might play out in 2024.
We are currently living in a world that is constantly changing. Over the last 40 years, we had a period marked by declining interest rates, which was favourable for equities. However, things are already changing, and we need to prepare ourselves for a future where interest rates are higher for longer. For a long time, we enjoyed the benefits of globalization, when economic barriers between countries were significantly reduced. However, we are now seeing an increase in trade barriers between countries and a trend towards countries turning inward.
A formidable skill to navigate this ever-changing and uncertain environment will be our ability to embrace ambiguity. It is the ability to adapt to new information, continuously learning in the process, and the willingness to challenge our assumptions and beliefs to align them with the changing circumstances.
AMN CAPITAL 