As they say markets surprise you all the time. After a volatile and moderate performance till October Indian Markets along with most of the other global markets took off at October end and the Nifty rallied by 14% over the last two months itself. Most global markets ex of China also performed strongly and many markets moved to 52 week or all time highs driven by the belief of inflation being finally under control and peak interest rate theory. I have been bullish on the outlook for 2024, however the last two months strong rally reduces the return potential for 2024 unless we actually see interest rates move down and provide growth impetus above currently estimated growth rates. Overall the Nifty ended up 20% in 2023, Midcap Index by 46.9% and the Smallcap Index by nearly 55%.
At the beginning of the year my view was to be cautious over this year as higher interest rates and stubborn inflation would drive equity valuations down. This played out quite well. We had strong buy calls in March and then post correction at October end which also played out quite well. Geopolitical concerns ebbed even though the Middle East conflict still continues and we also saw economic data come out of most economies which supports the soft landing argument and global bond yields corrected significantly from elevated levels. The US Dollar Index also sold off and gave up all the gains of 2023. Gold staged a good rally and is setting up for a strong 2024.Nifty had the best month of the year this month and the Midcaps underperformed a bit in December but did very well in the year 2023.
The one thing that investors keep in mind amidst the euphoria playing out in the stock markets, especially the bubble in the IPO Market where companies are coming out with issues at absurd valuations and then getting listed at even more absurd valuations is that things eventually revert to mean. The purpose of higher interest rates is to slow down economic growth so that inflation comes under control. The possibility that economic growth might be slower at a global level in 2024 than being currently estimated is a risk to the stock markets. In the Indian Context the growth paradigm is stronger despite the interest rates being higher than what is ideally desired given that most of the Consumer Inflation at this stage is due to food and not segments that can be directly impacted by interest rates.
The overall outlook for 2024 for equities in general looked strong as I have been writing over the last two months driven by Peaking inflation, easing bond yields, a stabilizing China and a weaker US Dollar will help emerging markets where overall valuations are at off multiyear lows but still lower than historic valuations. ( Indian valuations are above long term averages)
State Government Elections results in December indicate a continuity at the Centre which will be positive for policy continuity and economic growth. While it is tricky calling elections at this stage it seems like a done deal. The challenge with a single party domination is that government can take actions which could be in a way random or autocratic. As an example the sudden volte face on the Ethanol Policy suddenly made the sugar and ethanol story very uncertain from a long term growth story in December. Similarly industries relying on government dole outs like PLI etc run the risk of sudden policy changes.
The significant bounce back in global markets are creating some red flags like the CBOE VIX now at lowest since March 2020, flows into US Equity Funds touching multimonth highs with December seeing a week where inflows into US Equity Funds were as high as $ 20 billion a multimonth high and some amount of complacency. As such investors have to be ready for sudden sharp corrections of 5-10% at any time which could last a few weeks.
I am repeating a data point that I had put out a couple of months back. In the Indian context we also have the general elections in six months. Every election year this millenium has been positive
2004 Nifty up 11%
2009 Nifty up 76%
2014 Nifty up 31%
2019 Nifty up 12%
As I had expected FII flows have come back strongly which has helped large cap performance. If the US Dollar Index remains subdued an Chinese Economy shows stabilization flows into Emerging Markets should be strong in 2024. The valuations of midcaps overall are not cheap, however there are huge opportunities in specific stocks. Historically during declining rate cycles we always see Mid and Smallcaps outperform. We just need to identify the right companies and time entries. There will be opportunities across the board in 2024.
In a nutshell we continue to be constructive about equity markets. Many companies are doing well as the economy continues to grow at 6.5-7%. With large number of IPO’s and new listings we will also see opportunities in some of those companies after prices cool off from very elevated levels as current valuations in them are in a bubble. An increasing investment pool is always positive.
While we are constructive we also need to evaluate what can go wrong. So if we play the devils advocate and evaluate a declining US Dollar, stabilization of the Chinese Economy and any pick up in demand can lead to spike in commodities which could challenge the current peak inflation and eventual rate cut theory. Any change in stance by global central banks can lead to sudden jerky corrections in the stock markets and all of us need to be ready for the same. The current huge premium on valuations of Small and Midcaps that we see have historically never sustained. Many retail investors tend to go into more and more of momentum stocks irrespective of valuations. Investors need to be cognizant of this risk and be ready for mean reversion which can be brutal at times.
Market valuations are 10-15% above historical valuations at this stage which is a barometer to consider but not the only one. Mid and Smallcap valuations are much higher than historical valuations and that is a short term concern for this segment. India’s Market Capitalization to GDP ratio has crossed 120%. At the peaks of the bubbles of 2000 and 2008 we saw it cross 150% however after that the selloffs tend to be brutal. It is better if there is some correction in between and some time correction so that markets become healthy in the near term
Overall equity markets should given high single digit or low double digit returns in 2024 as longer term prospects look strong