After a year of outperformance, Indian equity markets to see turbulence

From all-time highs to heightened volatility, The second of the yearender series assesses the market's trajectory

The highlight of 2022 for Indian equity markets was its resilience and its better performance vis-à-vis its global peers. The road ahead, however, is likely to be bumpy, at least during the first half of 2023. A combination of stretched valuations, global headwinds, and peaking is likely to take some sheen off Indian equities.

Worries about major central banks, including the Federal Reserve, extending their aggressive monetary policy and the resurgence of Covid fears amid rising cases in China have made the Indian equity benchmarks give up some of their gains. From the all-time highs they saw in December, the Sensex fell 5.7 per cent and the Nifty 5.6 per cent. On a year-to-date (YTD) basis, the Sensex is sitting with a gain of 2.7 per cent and the Nifty with 2.6 per cent.

Calendar year 2022 was turbulent for global equities due to runaway inflation, disruption in commodity prices because of the Russia-Ukraine war, lockdowns in China, and the unwinding of post-pandemic stimulus measures. From being dismissive, central banks had to prioritise fighting inflation even if it meant compromising growth. The global headwinds led to a flight of capital from equity markets across the globe, including India. But the relatively better prospects of the Indian economy and strong domestic flows helped Indian equities to remain relatively unscathed and the benchmark indices to hit new highs.

A fresh pivot by the US Federal Reserve could be a big driver for the global markets next year. But given the new economic data in the US, which has strengthened the case for the Federal Reserve to extend its rate hikes, the wait could be longer than what the markets had anticipated.
 

“Any signs that inflation is brought under control will likely loosen central banks’ restrictive stance and can therefore trigger a rerating in equities. However, we do not think this will be the case in the first part of 2023 as our economists do not forecast rate cuts from major central banks, including the US Federal Reserve, in 2023,” said a note by Credit Suisse.

Even if there is some recovery in global equities, some of India’s peers that were oversold in 2022 could appear to be better prospects. The domestic markets, on the other hand, will have to let others play catch-up to narrow the valuation differential.

“We (Indian markets) are very expensive relative to global markets. India has done well this year, not in terms of absolutes but in relatives. We are one of the best-performing markets this year, and we will probably underperform next year,” said Jyotivardhan Jaipuria, founder, Valentis Advisors, a portfolio management services company.

G Chokkalingam, founder, equities research and advisory firm Equinomics, said global recovery means oil could become dearer again, and that will exacerbate India’s inflationary pressures.

Moreover, a section of the market believes that India’s growth has already peaked, and a broad-based slowdown is under way.

“We expect GDP growth to slow sharply below consensus to 4.5 per cent year-on-year in 2023 (consensus is 5.8 per cent) from 6.7 per cent in 2022, mainly due to global headwinds amid the domestic K-shaped recovery,” wrote Sonal Varma, managing director and chief economist (India and Asia ex-Japan), Nomura, in a recent note.

Analysts said the global growth slump might play an outsized role in influencing domestic growth in 2023, with exports likely to fall precipitously, especially during the first half, when the global hit will likely be most severe.

“The private capex upcycle has remained lacklustre, while global uncertainty and tighter financial conditions are likely to weigh on corporate investment plans, resulting in weaker fixed investment growth. Higher domestic interest rates will also impact the cyclical sectors,” the Nomura note said.

However, the second half could be more benign for Indian equities as the economy’s growth prospects are better in 2024.

“We believe India’s improved medium-term growth prospects, young population, stronger fundamentals and prudent policymaking, alongside the trend of supply chains diversifying away from China, should attract more investors into India in H2 2023, thereby creating a virtuous cycle by easing financial conditions and setting the stage for a stronger 2024,” Varma noted.

Jaipuria said as global headwinds fade, India would attract more capital inflows in the second half of 2023.

"The second half will be better for markets than the first half because people will be worried about a US recession in the first six months,” he said, adding, “Those fears will settle down as we move to the second half, and probably the year after would be great for the economy, so people will start buying equities. One always wants to buy at the end of the recession."