Indian stock market outperforms the global market, makes for attractive investment

 

A clear mandate favouring the BJP in the Hindi region has ignited an alluring gap-up rally, yielding a notable 3.5% WoW return in the broader market. After a period of underperformance in the past 1-2 months, India has now positioned itself as an attractive investment by outperforming the global market. MSCI 1-month’s return is 8.0% compared to MSCI World’s 5.2%, 1Yr is 12% vs 13.8%, respectively. This favourable outcome positions India attractively, fostering expectations of an enticing domestic pre-national election rally in anticipation of sustained reforms and policies. Such a scenario serves as a key attraction for foreign funds, encouraging them to maintain a positive outlook on the country.

Simultaneously, globally, risk-on strategies are gaining momentum in anticipation of the apex of the interest rate cycle. The Fed is expected to make its first cut between March to June 2024, a consensus view. And currently, the bond yield from a high of 5% (US10yr) has corrected to 4.18%. This downward trend in yields is anticipated to persist in the short to medium term, propelled by expectations of easing inflation, geopolitical risks, and an impending economic slowdown.

In light of the current dynamic, a positive trend is evident in both global and domestic markets. However, it's crucial to acknowledge the flip side of the coin, as complete resolution may not be imminent. On the international front, the expectation is that the decline in bond yields may not be a prolonged phenomenon. This is because inflation is still expected to stay above the long-term trend in CY2024 due to high fiscal and consumer expenditures. The current consensus is that US CPI will drop to 2.4% in Q4CY24 from the current 3.2%, which will help bond yield narrow further. However, the extent of further downfall will be muted as economists forecast the average 10yr yield to be 3.9% in 2024.  

This stems from the fact that the CPI forecast remains elevated compared to the long-term average and the FED's target of 2%. And the current downward yield trend will have to hurdle with the rigid inflation trajectory. Past data reveals that the U.S FED typically hesitates to implement rate cuts when interest rates are already high, limiting the extent of potential cuts. The significant contraction in yields observed presently seems to be a reactionary response, driven by the expectation of a drastic shift in monetary policy, the probability of which is still subdued. 

Domestically, the hurdle is that we are in an El Nino year. This is expected to affect the yield of Rabi cultivation, which will have a negative effect on the rural market and food prices, affecting the whole economy. There is even a potential impact on the onset and behaviour of the 2024 monsoon, although definitive assessments are premature at this juncture.

The progress of sowing Rabi crops is down by -5% YoY in Dec 23. The November water level in reservoir is -22% lower than last year, which is 10% below the long-term average. Foodgrain prices have already started to shoot, like millets, sugar, onion, and tomato. Hence, inflation in India is likely to stay elevated in H2FY24, limiting RBI repo rate cuts.

Finally, a prevalent concern in the stock market pertains to high valuations, posing a contrast to elevated yields a. And even if the US yield drops from current 4.18% to 3.5% in Dec 2024, it is still above the long-term average, which does not support the current valuation to sustain. One yr. forward P/E of the US is at 21x compared to the long-term average of 18x. India is at 20x compared to long term average of 17.5x.