The month of August was an extremely volatile month for the stock markets where the markets initially sold off due to the sharp yen appreciation and unwinding of the Yen carry trade and then immediately bounced back to end flat to positive for the month. The spike in volatility in the initial part of the month was intense but unlike past events cooled off rapidly. Markets got support from the expectations of an easing monetary policy stance by the US Federal Reserve including stable economic data which reduced the risks related to a hard landing in the US Economy.
August also marked the end of the results season for the first quarter which was an average result season overall with earnings growth for the composite basket of companies at just around 5% although there were many companies that did well. The technology sector sharply outperformed during the result season drive by belief of bottoming of the growth cycle and expectations of improved growth. Most commodity companies continued to report subdued results and the outlook remains hazy as the Chinese Economy continues to remain stressed. Capital Goods and Infrastructure companies saw subdued results driven by election related slowdown in execution while margins held up. Overall outlook continues to be constructive. Automobile company results in general were better than expectations driven by improved margins as input prices remained subdued and value growth was better than volume growth. Near term outlook here is hazy due to high system inventories, however a good monsoon should see demand recovery by the festival season. Telecom sector continued to do well and strong performers were the pharmaceutical and consumer durable sectors driven by improving growth and benign input prices. Pharma as a sector has seen a sharp earning recovery overall. FMCG and other consumer non durable companies results were still subdued but most companies have given a positive outlook which supported stock prices. Financials in general reported at par or below par results. This is the sector, especially banks could see stressed earnings next year driven by tight liquidity and growing RBI lending restrictions. This can overall be negative for economic growth also. Real Estate companies continued to report strong growth and good response to new projects. Real Estate is always a high employment generation industry and the sector doing well also creates ancillary demand from many other sectors like wires and cables, tiles, sanitaryware etc.
Overall market valuations have continued to expand with the largecap indices today trading at valuations of nearly 25X earnings which is not in bubble territory but nearly 30% more expensive than long term averages. More concerning is the Market Capitalization to GDP ratio which has crossed well over 150% which historically has been not a good indicator for immediate future returns. Mid and Small cap valuations continue to be higher than largecap valuations and speculative activity is high and that is a concern for the overall markets. The equity supply has also gone up sharply with almost on a daily basis there being sales by promoters, IPO’s, sell off by private equity companies of nearly Rs 5000 to Rs 10000 Crores. Overall equity supply for the current year 2024 has already crossed Rs 130000 Crores. Much of this has got absorbed due to the huge inflows into Mutual Funds, PMS and AIF products, however the question remains till how long. The quality of IPO’s has also been declining and valuations expanding. The primary market froth is much greater than in the secondary markets today.
We have seen what happens when fancied sectors where everyone is loading on to top off. We have seen sharp selloffs in PSU’s, Defence and Railway related stocks. Sell offs from frothy sectors can be as high as 20-50% and investors need to be careful even though long term growth prospects might be strong.
Economic data this month showed that inflation was below expectations and Industrial Production Data was also below expectations. With RBI trying to fight monetary policy with tight liquidity there is a risk that slowing bank credit could impact the overall economic growth going forward. The other key phenomenon is growing socialistic measures by the central and state governments with increased cash doleouts via various schemes and also the introduction of schemes like the Unified Pension Scheme also indicates some moderation of the overall reforms process and could create fiscal stress especially within the State Governments which follow the Central Goverments steps. This could also reduce the overall fund availability for capital investment and thus infrastructure development. Which the Union Budget indicated steps towards fiscal consolidation remains strong we need to see how things evolve. Announcements on various developmental projects is still progressing strongly atleast from the Central Government. Key is to monitor state level investment cycles. Normal Monsoons is a key positive as that will not only reduce food inflation pressure but also help economic growth.
Overall market valuations at this stage seem to be stretched looking at the growth and earnings paradigm. While opportunities present themselves in specific stocks and sectors the more markets continue to rally without any significant correction the more the risk of a sharp near term correction increases. Many companies continue to do well and particular sectors are ignored at various points of time due to different reasons and provide contrarian investment opportunities.
I continue to be overall constructive but would like to hold cash on the sidelines to invest. When returns have been so much above historical averages in the preceding three years normally the next three see subdued overall market returns. It will become more and more a stock pickers market.
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