Can India’s equity market rally last much longer?

Please note: This article is written by our Investments team in India, and may reflect a different positioning versus portfolios managed in other regions.

All data referenced in this article is sourced from Refinitiv Datastream unless otherwise stated, and is accurate at the time of publishing.

Key points

• The rally in Indian equities and bonds continues despite potential headwinds like reduced rate cuts, upcoming elections and ambitious earnings expectations  
• That said, positive factors like healthy domestic demand, easing inflation, and improved government tax and spending figures are boosting sentiment 
• Within equities, domestic cyclical sectors like power, manufacturing, infrastructure and capital goods are currently favoured, along with select consumer discretionary segments. Additionally, domestic listed and private credit offer attractive yields, and can complement medium-to-long duration investment strategies
• For investors with a two-to-three-year horizon, staggering investments in the coming months may be prudent due to potential market volatility as earnings growth, election results and future rate cuts unfold

In February, financial markets around the world moved away from expecting US rate cuts by March. At the same time, several rate cuts are still anticipated for 2024 in many developed markets. The lag effects of earlier hikes on growth, and if the steady decline in headline inflation rates can be sustained, may warrant some easing, as guided by their respective central banks. The data on prices seen in recent months seems to support central banks’ guidance on rates. 

Turning to India, steady economic growth supported by healthy government capital expenditure (capex) spending has been the main economic theme in recent months. The Interim Union Budget for fiscal year 2024-25 (FY25) estimates that the country’s gross fiscal deficit (GFD) will be 16.9 trillion rupees, down by around 3% from the prior fiscal year ending March 2024. 

The GFD is projected to be 5.1% of FY25’s gross domestic product (GDP). This compares to well below a revised estimate of 5.8% for the current fiscal year, which has also been trimmed by 2.5% from earlier estimates, following higher tax revenues and less capital expenditure than anticipated. In addition, a stable external sector balance sheet, aided by services exports, provides a strong anchor for the currency. 

At the same time, recent data prints point to encouraging progress towards aligning the consumer price index closer to the central bank’s policy target. Overall, domestic demand and activity levels remain healthy, as urban consumption and the capex cycle remain firm. 

Indian equities well supported by outlook for earnings, general elections and rates

Despite climbs in markets, Indian equities continue to look well valued from a long-term perspective. Even as domestic markets have performed well compared with their peers (India’s BSE 500 being up almost 13% versus the 11% gain for the S&P 500 in the US in the last three months), dispersion in sector may increase in India, with performance in some sectors (such as public-sector undertakings) particularly at risk of moderating somewhat in the coming months following their strong performance of late. 

Valuations of domestic equity markets are likely to continue heading higher, given the government’s chances of being re-elected this year and the authorities’ focus on capex, manufacturing and digitisation. 

Looking at market valuations, the relative risk-reward may seem unfavourable for mid- and small-caps versus large-caps. The ratio of the market cap for the Sensex (covering the 30 highest capitalised Indian stocks) to the BSE 500 (representing the top 500 stocks) is at a multi-year low (the level being 42% against its 20-year historical average of 48%), suggesting that valuations favour large-caps on a relative basis. However, given the stronger earnings growth witnessed recently and expected for some mid-cap companies, investment opportunities in this space should continue to emerge.

While investors’ recent exuberance is visible in pockets of markets, with outbreaks of heightened volatility likely, portfolio risk control will be important, as will ensuring diversification and a focus on quality equities in 2024. Investors with a two-to-three-year horizon might want to stagger investments as earnings growth, election results and the pace of rate cuts unfold. Domestic cyclical growth remains our most preferred theme, including sectors like power, manufacturing, infrastructure, capital goods and select consumer discretionary. 

Opportunities in duration and credit 

Consistent foreign investor flows into Indian assets since September have supported the demand for government bonds. Sentiment has been further aided by a larger-than-expected fiscal consolidation and a gross borrowing forecast for FY25 that is around 1.2 trillion rupees less than in FY24. In addition, the Reserve Bank of India has conducted calibrated repo auctions to reduce any liquidity stresses. 

Overall, despite the recent increase in yields globally, significant domestic fixed income demand has helped longer-end Indian government securities to outperform. Broadly speaking, adding duration to Indian bond portfolios seems appealing over an 18-24 month investment horizon. Additionally, the strong economy and improving corporate balance sheets are a positive for AA and A-rated credit, which continue to provide attractive yields. 

Meanwhile, private credit tends to perform well when the economy is humming and corporate balance sheets are buoyant, as is currently the case. In addition, we continue to view gold as a key portfolio diversifier.

Keep it simple 

Following the recent rally in domestic equities and bonds, the key question is whether and how much longer it can last. Investing does not always need to be exciting. Having a simplified approach to portfolio asset allocation can be rewarding too. 

The longer one stays invested, the higher the potential to boost your wealth. There is a risk that short-term, knee-jerk investment decisions may ultimately be costly. Having a thought-through, long-term investment strategy that is based on your risk appetite, and staying focused on the investment objective in the face of market volatility (or noise), gives you a better chance of overall success.

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