Can Indian equities keep outperforming for long?

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

• Indian economy continues to shine. The country’s forecast growth for 2024 has been lifted to 7.1% by Moody’s, though a slowdown to 6.5% seems to be on the cards next year. With inflation, and the current and fiscal deficits under control, economic prospects augur well.
• The Indian central bank is expected to join the US Federal Reserve and others in cutting rates soon. This should help to support the bond market, with an anticipated softening across the curve.
• Curated lower-credit issuers (AA and lower) continue to offer value for those willing to hold investments over an 18-24-month period, with credit spreads above their long-term average. 
• Indian equity valuations appear stretched after their strong run seen this year. As such, we are now neutral on the asset class and retain equal preference for large-caps and small- and mid-caps (in line with weights in the benchmark BSE 500 index).

India’s growth forecasts continue to remain upbeat, if slowing in the longer term. Moody's has revised its calendar year (CY) 2024 growth forecast for the country to 7.1%¹, from an earlier estimate of 6.8% in June, with Asia-Pacific growth set to outpace the global economy. However, India’s growth forecast for CY 2025 was unchanged, at 6.5%. 

After much government spending on capital expenditure in recent quarters, this is slowing to a more normal level. Meanwhile, households continue to add debt, providing more spending power. While a broad-based consumption recovery is not yet happening, some concentrated demand can be seen in the premium segment of the market. 

With monsoons remaining in line with expectations, it points to nascent signs of recovery in rural demand and private capex, which should help to ensure more broad-based growth. Overall, with higher gross domestic product (GDP) growth on the cards, inflation under control, visible political stability, a demographic dividend and current and fiscal deficits under control, it all augurs well for the economy. 

In turn, this backdrop could help to support continued investor allocations to the country, whether as part of global equity or debt portfolios. That said, beware of short-term news flow potentially upping volatility. 

Long-term positive, short-term caution

After their strong run this year, equity valuations remain stretched, and are regularly hitting new highs. The market is navigating well a volatile period for many global regions. Volatility remains subdued, for now, and implied expectations remain high. 

However, investors will watch the upcoming earnings seasons closely, along with the local state election results, US elections and rate moves by central banks. In that respect, following September’s US Federal Reserve rate cut, foreign portfolio investment flows are strong ($11 billion so far this year), and along with sizeable cash holdings and domestic mutual fund flows of $20 billion, this is creating a scenario where liquidity could continue to drive markets higher in the near term. 

Despite the recent upbeat mood and while equities, as an asset class, appear to be well placed from long-term perspective, one should expect moderate returns from hereon. 

Large-caps are trading at relatively attractive valuations compared to their mid- and small-cap peers, where valuations appear overextended. Investors might focus more on sectors where margins of safety seem superior and look to stagger fresh investments.

While cyclicals outperformed in the run up to this year’s Indian elections, as more political clarity has emerged, they have since lost momentum to defensives. But through both these periods, private banks have continued to underperform. As the earnings gap with the broader market narrows and liquidity conditions ease. Current valuations remain attractive for the financial sector to perform better in coming months.

In addition to financialisation, themes such as digitisation, aspirational consumption, formalisation and a manufacturing renaissance suggest a once-in-a-decade capex recovery for years to come.

While the outlook is encouraging over the long term, tactically speaking it might make sense for some investors to book profits and take some money off the table in light of apparent exuberance in select pockets, and given concerns around valuations. As such, we are now neutral on Indian equities, and suggest reviewing portfolios from an asset-allocation perspective. We retain equal preference for large-caps and small- and mid-caps (in line with weights in the benchmark BSE 500 index).

Central bank stance change remains first priority

Global monetary policy dynamics are a large trigger for global liquidity and flows. India is well-placed among other emerging market economies in this respect. This has been reflected in the robust debt flows seen of late following the country’s bond index inclusion in recent months. 

The Reserve Bank of India (RBI) remains eagle eyed on domestic inflation dynamics in its decision-making process. Headline inflation is expected to remain above 4% for fiscal-year 2025. With the headline inflation number below the target, a modest rate cut looks possible soon, if not as steep as the half-point actioned by the Fed last month. 

The RBI’s rate hikes have been less severe compared to the Fed’s, and with a shorter path to normalisation, the RBI has more flexibility. This allows room for a more gradual approach, possibly beginning with a shift in stance before proceeding to a rate cut. Our view on rates remains optimistic, with fundamentals aligning with the positive outlook for the fixed income market, aided by an expected softening across the curve.

Curated lower-credit issuers (AA and lower) continue to offer value for those willing to hold investments over an 18-24-month period, with credit spreads above their long-term average. 

Gold and private markets

Gold continues its traditional role of acting as a perceived reliable store of wealth, even in turbulent times. With rising geopolitical tensions, anticipated lower US real rates, a weaker US dollar and continuous central bank buying, the yellow metal remains an attractive option for investors. In particular, it can help to balance the portfolio risks associated with other asset classes in volatile periods.

In addition, private market opportunities, including privately-listed REITs and InvITs, may also offer another route to creating well-diversified portfolios for some investors, targeting better portfolio-adjusted returns for some investors. That said, they can be complex and illiquid, and so may need careful consideration prior to investing.