– By HDFC Asset Management Company Limited
With the continuation of the market fall in November, frontline Indian equity indices such as the NIFTY 50 Index (TRI) are down ~10% from the recent high of September 26, 2024. A host of factors seem to be driving it, including flows related (aggressive FPI selling, large IPO / FPO activity), and fundamentals related (some disappointment in corporate earnings in Q2FY25). A key reason for the growth slowdown is being reported as the slowdown in government spending, which could reverse significantly in the second half of Financial year 2025 (H2FY25). In this note, we try to assess the dynamics of the market fall to see where opportunity could lie (Hint: Largecaps).
Amongst size classes, largecaps, midcaps and smallcaps have seen similar falls at the headline level, ~11% from their respective highs. While the correction gives an overall valuation comfort, the almost equal fall across market caps means that the valuation gap that was seen amongst the different size classes remain, with midcaps and smallcaps trading at relative premiums to largecaps and their own history.
Among sectors, there is some divergence, with sectors leading the fall being the ones that saw the largest increase in their levels in the recent few months / years.
In the current earnings season, a large number of companies reported results that were worse than analyst expectations. This led analysts to further reduce their estimates of earnings growth. In fact, despite this reduction, overall medium term profit growth estimates remain healthy across market segments. As seen in actual earnings growth in the past few years, expected earnings growth is higher in midcaps and smallcaps.
Government spending in FY25 so far has been slower than the previous year, being only 43.8% of total budgeted expenditure by September, vs 47% last year, with spending being particularly slow on the capital expenditure front (down by 15% YoY in Apr-Sep). This has been ascribed to reasons such as the union elections and large state elections, irregular weather patterns in certain areas, etc. A simple analysis of the budget numbers suggests that to meet the expenditure numbers mentioned in the Budget document released in July 2024, the central government will have to spend at a significantly higher rate, which could be ~17% higher YoY for the rest of the year.
Government spending slowdown is a potential cause for slowdown in aggregate economic growth, as well slowdown in consumption. A reversal in H2FY25 could have a positive impact on the economy and corporate revenues.
Our medium to long term positive outlook on Indian equities remains unchanged driven by the structurally robust domestic growth outlook, healthy corporate profitability, and supportive pro-growth policies. India remains amongst the fastest growing major economies, and is expected to retain that position as per IMF forecasts. Near-term risks include escalation in geopolitical tensions, slowdown in government’s reforms momentum, weakness in global growth, etc. Some of the geopolitical unknowns have now moved to the known unknown territory, and are therefore possibly priced in already.
While valuations have improved post the recent correction, they are still at a premium to their historical averages. With the fall being almost equal across size classes, valuation premiums for midcaps and smallcaps versus largecaps remains largely unchanged. As mentioned in our Insights document from July 2024, FPI selling could abate / reverse, and largecaps could be well placed in such a scenario. In fact, in the note titled “Bull Market Corrections…”, we highlight how FPI linked sell-offs could be an opportunity to increase allocations to equities as an asset class.
To conclude, one should keep in mind that asset allocation drives portfolio returns, and that staying invested for the long term is paramount. Periods of volatility tend to improve the Rupee cost averaging benefit from SIPs.
(The article is authored by HDFC Asset Management Company Limited.)
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