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Informist, Tuesday, Dec. 31, 2024

 

By Anjana Therese Antony

 

MUMBAI – The year 2024 was when the Indian equity market, often a global standout, underperformed. The year was brimming with challenges, from the market regulator's warning of frothy valuations in mid-cap and small-cap stocks to the dampener of possibly slower interest rate cuts next year by some global central banks, not to mention heightened geopolitical tensions in West Asia and Europe and yo-yoing crude oil prices. Among the other challenges were expensive valuations, sharp foreign fund outflows, disappointing corporate earnings growth, an economic slowdown, and rupee depreciation. The upshot was that equities delivered sharply lower returns. Only India's growth prospects over the medium-to-long term prevented a steep fall in equities, analysts said.

 

"India has underperformed global markets," said Dhananjay Sinha, co-head of equities and head of research at Systematix Group. "The returns from the Nifty 50 are about 8%, compared to 20% last year... This is significantly lower than the earning expectations people had."

 

While the 8% rise in the domestic benchmark gauges was better than the 4% rise seen in 2022, it was much lower than the growth seen in their counterparts in the US, Asia, and Europe. The Dow Jones Industrial Average rose 13%, the NASDAQ Composite rose 30%, China's CSI 300 Index gained 15%, Hong Kong's Hang Seng Index rose 18%, and Germany's DAX Performance Index was up 19%.

 

The second half of the year saw a bear run in India, particularly after October, owing to a slowdown in domestic earnings growth, stretched valuations, foreign investor outflows to the US in anticipation of an economic boost from the new administration of president-elect Donald Trump, and stimulus measures in China. The benchmark indices rose 17.5% in the first nine months of the calendar year and shed half of these gains in the remaining three.

 

Expensive valuations are not a new problem for the Indian stock market. The issue has been dogging it for at least two years. Even after the three-month correction since October, research analysts and fund managers say stocks need to fall further for valuations to reach reasonable levels, which could then trigger foreign fund inflows.

 

Valuations have fallen about 8?ter the recent pull-back, but they still trade at nearly 23 times the forward price-to-earnings, which is above the 10-year mean and higher than the fair value estimate of 21 times the price-to-earnings, Goldman Sachs said in its market outlook report for 2025. This indicates a further derating risk and the market is expected to remain range-bound over the next three months, it said.

 

Stretched valuations and poor earnings growth were the primary causes that triggered a sell-off by foreign institutional investors, who have also increasingly added short positions in the market amid a bearish outlook. Consequently, their net purchases of equities worth $884.28 million in 2024 were less than 4% of what they had bought in 2023.

 

"If you see the FII holdings in the total market cap (capitalisation) of India, it is at a decadal low... there will be some concern on the FII outflow for the near term. But I'm really confident about the long term," said Sanjeev Hota, vice-president and head of research at Mirae Asset Sharekhan. Once there is an improvement in earnings performance in FY26 and FY27, there is every possibility of foreign investors returning to the Indian market, he said.

 

The slowdown in earnings growth of India Inc., particularly in the third quarter of the calendar year, and the earnings downgrades that followed, simply made matters worse for investors. The on-year revenue growth of Nifty 50 companies moderated to a 15-quarter low of 6.6% during the September quarter, and that of Nifty 500 constituents was at a three-quarter low of 8.3%, according to the National Stock Exchange’s corporate performance review report. Also, the adjusted net profit growth of Nifty 50 and Nifty 500 companies declined to an eight-quarter low of 0.8% and 4.1%, respectively, it said. 

 

The downgrades in earnings estimates added fuel to the fire. Following the poor Jul-Sept performance, the earnings growth estimates for FY25 for the top 200 companies by market capitalisation were cut to 6-7%, from the earlier anticipated 10-11%, analysts said. Energy players saw the most downgrades, while real estate was hit the least, they noted.

 

Some of the blame for the slowdown in earnings growth goes to the extended monsoon, higher input costs, and lower government orders due to the general election and several assembly elections. The biggest intraday fall of 8% in almost four years was recorded on June 4, when vote-counting data suggested that the ruling Bharatiya Janata Party was at best likely to win only a slim majority. As it turned out, the party was able to cobble together a majority only with the help of allies, after which the market began recovering.

 

Another pain point for investors during the year was the volatility in global crude oil prices, which rose above the $90-per-barrel mark in April amid a worsening conflict in West Asia. Adding to the woes was the continuing war between Russia and Ukraine. India, which imports over 80% of its crude oil needs, felt the heat of the surge in prices. However, anticipation of lower demand in 2025 and likely higher production by some countries that are not part of the Organization of the Petroleum Exporting Countries and its allies helped to ease prices. At 1623 IST, Brent Crude futures on the Intercontinental Exchange were up 0.7% at $74.51 per barrel.

 

The hike in capital gains tax announced in the full Budget in July also came as a bolt from the blue. Investors were, in fact, expecting a reduction in the tax. Finance Minister Nirmala Sitharam announced an upward revision of the long-term capital gains tax to 12.5% from 10?rlier, and in short-term capital gains tax to 20% from 15?rlier. 

 

SILVER LINING

Given all the challenges, one may be wondering whether there was anything positive about the year for investors. The answer from many analysts is "yes". The correction in itself is seen as good news. Analysts say the fall was needed, as returns were lower not just because of near-term weak fundamentals, but also on account of rich valuations. Fund managers said the correction took the Indian market to a somewhat better position and a further fall is needed for investors, particularly FIIs, to make fresh buys.

 

The earnings outlook for small-cap stocks remains strong and they are trading at a lower valuation premium over large-cap stocks, Standard Chartered said in its market outlook report for 2025. "We upgrade mid-cap and small-cap equities to 'neutral' as improving banking system liquidity, stable earnings outlook, and resilient domestic investor demand through systematic investment plans should offset concerns on stretched valuation premiums that remain close to peak," it said.

 

Earlier, the "froth" built up in the mid-cap and small-cap space had caused concern, especially as many investors were "blindly" investing in shares of companies that did not have sufficient growth prospects. The Securities and Exchange Board of India had also raised a red flag, saying "it may not be appropriate for that froth to keep building".

 

The regulator also introduced measures to reduce the exposure of retail investors in the derivatives segment, which analysts said was a necessary step to reduce the losses being made by such investors. One such measure was to restrict the weekly expiry to only one benchmark index per exchange. As a result, the weekly index options contracts were discontinued for the Nifty Bank, Nifty Midcap Select, and Nifty Financial Services indices.

 

Some of the other "good news" includes optimism about a pick-up in the government's capital expenditure and the frenzy around initial public offerings. The year saw companies raise a record INR 3 trillion from the primary market through a mix of initial public offerings, qualified institutional placements, and offers for sale, ICICI Direct Research said in its note. This was more than double the fund raised in 2023, and indicates the maturity of the domestic market which offers substantial depth and liquidity for foreign investors, it said. 

 

Changes in monetary policies by some global central banks, including in the US and India, have also eased the cautious environment. The US Federal Reserve started its rate-cutting cycle in September, when it surprised global investors with a 50-basis-point reduction, then reduced the key rate by 25 bps each in November and December. However, with Trump returning to power, many believe his policies, including a possible reduction in corporation taxes, could push inflation higher. This may put pressure on the Fed to adopt a tighter monetary policy next year. This was also indicated in the Summary of Economic Projections, which indicated a 50-bps trim in rates in 2025, compared to the earlier projection of 100 bps.

 

The change in stance of the Reserve Bank of India to 'neutral' from 'withdrawal of accommodation' and the reduction in the cash reserve ratio in the latter half of the year boosted hopes of an improvement in liquidity in the banking system.  End

 

US$1 = INR 85.61

IST, or Indian Standard Time, is five-and-a-half hours ahead of GMT

 

Edited by Rajeev Pai

 

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