2023 Outlook: Indian Economy's Resilience and Rich Market Valuations

Our view on markets is colored by three factors. The primary factor is that despite the threat of a global slowdown owing to sharply tighter monetary conditions, the Indian economy continues to show strength in several areas. Secondly, however, valuations seem rich everywhere – despite 10-year yield being higher than pre-Covid by 70bps, Nifty forward multiple is higher by 20%. In the US, this is almost unchanged despite a doubling of 10-year yields from 1.8%. Also, the lag effects of sharp policy rate hikes around the world can disturb this rudely. The third factor is led by higher borrowing costs. There is a distinct bias towards earnings downgrades rather than upgrades, and it will pay to select sectors and stocks where earnings growth downgrade risk is minimal and better visibility might start attracting higher premiums. For instance, our calculations suggest up to 5% EPS downgrade for India due to higher borrowing costs. However on the geopolitics side, things couldn’t possibly worsen. Also read: Shankar Sharma stock that surged 2500% last year now among worst performers The strength of the Indian economy is evident through a number of indicators. Surveys show improving consumer sentiment, closing in on pre-Covid levels (quite the opposite in advanced economies), PMI both manufacturing and services at 55+ on a sustained basis, strong volume compounded annual growth rate in production of steel and coal etc. Government tax collections are likely to beat budget estimates, but while they will be neutralized for some time by cost overruns in food, fertilizer and fuel subsidies, given recent trends in commodity prices. However, these cost overruns may not last for long, and rapid fiscal position improvement might happen in 2HFY24. Corporate leverage are at a 9-year low, and with banks having raised capital, the The twin balance sheet problem is all but gone. Reform momentum has been strong in the last 3 years and should sustain. Forex reserves are substantial, and external debt to GDP is low compared to other countries. But, these strengths may not protect against downgrades, especially if major economies led by the US suffer a recession. The biggest economy, the US, has seen very large hikes and at a very high pace (425bps in 9 months) and one can expect the negative impact to echo internationally, including some impact in India. Our house research’s GDP growth estimate for FY24 of 6.5% (for now) is below consensus, and we might downgrade further. But on the other hand, we expect inflation to continue to fall steadily, faster than historically as China reopening can restore supply chain capacities rapidly during 2023, while impact on commodities is neutralized by global slowdown. Hence central banks may pause soon, and likely, so should RBI. Hence growth downgrades may be significant but not alarming. Catch all market stories here Nifty trades at 20x one year forward, and P/B of 3.0, more than 1.1 SD above long term mean. From these levels substantial market returns unlikely, though some modest upside might occur thanks to superior growth momentum in the economy relative to other major economies inspiring confidence. A scenario where positive returns can happen is if the badly battered geopolitical landscape sees some resolutions. Sector wise it is difficult to take sweeping calls as many sectors are heterogeneous, and the best approach is to pick stocks where a combination of specific strength in operating performance and a reasonable price is visible. We see the best combinations in select banks (Axis Bank, HDFC Bank, Ban of Baroda, Equitas Small Finance Bank), Insurance (SBI Life), some Pharma and healthcare names (Sun, Rainbow, KIMS and JB Pharma). An expectation of falling inflation means that low income consumers could see better days than they have in 2022 and hence FMCG names like HUL and Dabur can do well. In addition, Apollo Tyres (improving FCF and strong volumes) and Indigo (commanding market share plus crude not spiking in a slowdown context) should do well. We also like Macrotech – stretched tenors have offset mortgage rate increases, plus incomes have risen in middle and upper income segments of the population and volume strength should continue. Lastly, ESG is overhyped, and stocks like ITC that were frowned upon should come back into the reckoning once the ESG hype starts wearing off. The author, R Venkataraman is Chairman at IIFL Securities Disclaimer: The views and recommendations made above are those of individual analysts or broking companies, and not of Mint.