We don't sense any significant nervousness among investors: Saion Mukherjee

As the markets enter the new fiscal year, they are keenly eyeing the outcome of the general elections back home and the policies that the new government may unveil. SAION MUKHERJEE, managing director and head of equity research for India at Nomura tells Puneet Wadhwa in a one-on-one chat in Mumbai that sticky inflation and delay in rate cuts by the US Federal Reserve can emerge as a concern for the markets. Edited excerpts:

There are expectations of a harsh summer this time around. Are equity investors, too, likely to sweat it out in the markets in 2024?

It is going to be a harsh summer literally as predicted by the India Meteorological Department (IMD). We will also be in the midst of general elections, which will heat up things further. Sticky inflation and delay in rate cuts by the US Federal Reserve can emerge as a concern for the markets. Though delayed, the market is still assuming a soft landing. A narrative towards ‘no landing’ will be negative for the markets. Volatility is expected to rise; bottom-up and stock specific approach is recommended. 

Your view on mid-and small-caps?

At the index level (Nifty), the markets have done okay compared to other emerging markets (EMs). Of course, the developed markets (DMs) have outperformed EM so far this year. The nervousness, if at all, to an extent is in small-cap space where valuations were high. Even there we have seen a rally from the recent lows and the index now is flat YTD. We don’t sense any significant nervousness among investors at the moment.

By when will the foreign money chase Indian markets with 'animal spirits'?

The FII flows were little soft earlier in the year, but there was a pick-up in March. FII flows could accelerate sometime later in the year, as the Fed rate cut cycle starts (we expect first cut in July 2024) and soft landing narrative gains strength. Also, the political uncertainty will be behind us by then. With growth remaining strong, an out of turn policy rate cut by the RBI is not expected. We expect the RBI to cut rates starting August 2024.

Two of the biggest global economies – the US and India – go into polls in 2024. Will the policy landscape eventually define equity markets and fund flows over the next 12 - 18 months?

The policy landscape can have a bearing on the markets. For India, the market expectation is that the National Democratic Alliance (NDA) government will return to power and there will be policy continuity. This would imply continued focus on manufacturing and investment-led growth. This expectation is largely priced in. A weak majority or in the worst case, a loss for NDA, can lead to material policy uncertainty and adversely impact the current market sentiment.

In the US, a Trump win would lead to return of trade protectionism and reflationary macro policies (low interest rates and fiscal expansion). The economic impact for India may be limited, and India will likely benefit from supply chain shifts. However, the policies may lead to concern on sustainability of US fiscal, which can be negative for the markets.

How do you see corporate earnings play out in the next fiscal (FY25)?

We think the corporate earnings in aggregate have beaten street expectations in the recent past. For instance, for the quarter ending Dec 2023, we estimate that aggregate corporate earnings of over 200 companies that we track were 4 per cent ahead of the street's expectations, and that led to 1-3 per cent earnings upgrade for FY25/26.

The strength in corporate earnings in the recent past is driven by improvement in profit margins. Better pricing and lower costs benefited earnings. For most sectors, expectations of profit margin are elevated compared to long-term averages. Therefore, the earnings growth going forward is largely dependent on topline growth and margin levers are limited.

Slowdown in top line growth and rise on costs (oil price etc.) is a cause of concern. Such expectations are mostly factored into current estimates, as the street is expecting growth to slow to around 12-13 per cent in FY25 versus 28 per cent growth likely in FY24.

On public sector enterprises, we are particularly positive on banks and oil marketing companies (OMCs). The expectations on defense and railway themes are high, and there is not much valuation comfort.

Most surveys peg the average salary increase for Indian employees at around 9 per cent. That's barely beating inflation. How do you extrapolate this to consumption growth over the next few months and the outlook for related stocks in this sector?

With inflation heading lower, the real wage growth in rural India will improve. Rural consumption is expected to improve from the current lows. We see some softness in employment and slowdown in real wage growth in urban India; remain selective in the consumption space given high valuation in the sector. We like select Auto OEM and staple companies.