Despite current euphoria in market, returns in first half of 2023, modest

The rupee became the comeback kid, riding the crest of an FPI wave. Metals should forge ahead as should markets after a period of tumult

Notwithstanding the current euphoria in the market, the returns generated by equity markets in the first half of calendar year 2023 (CY23) have been modest. The S&P BSE Sensex has returned 5.1 per cent, while the National Stock Exchange Nifty has slightly underperformed, rising 4.8 per cent after going through a tumultuous period.

The broader markets have outperformed, with the Nifty Midcap 100 and the Nifty Smallcap 100 indices gaining 12.7 per cent and 10.9 per cent, respectively. The year began on a turbulent note amidst concerns over an unfavourable risk/reward ratio, thanks to high yields on debt products.

Foreign portfolio investors (FPIs) were net sellers as China’s reopening led to the reallocation of funds from India to China. In the first two months of CY23, FPIs sold shares worth Rs 35,229 crore, causing a nearly 10 per cent drop in the markets. A scathing report from US-based investment research firm Hindenburg Research on January 24 against Adani Group raised fears of contagion and spooked investors.

Moreover, the banking crisis in the developed world and uncertainty around central bank policies amid persistently high inflation weighed on sentiment during the start of the year.

During the first quarter of CY23, the Indian markets dropped nearly 4 per cent and were among the worst-performing major markets. Chinese equities rose nearly 6 per cent. However, domestic stocks saw a dramatic change of fortune during the second half, as 

FPIs — looking for an alternative to China — invested heavily in India amid an optimistic economic and earnings growth outlook. This helped India catch up on the underperformance.

Positive quarterly earnings numbers and healthy macroeconomic data, a fall in inflation, and an easing of fears of contagion were among the factors driving positive sentiment. In the first half, FPIs and mutual funds were net buyers of more than Rs 62,000 crore.

“It is the FPI flows that have helped the markets to stay afloat. The flows were driven by the realisation that India has managed the global slowdown well. The economy is doing well, and all the high-frequency numbers seem to be adding up,” says U R Bhat, co-founder, Alphaniti Fintech.

The pause in interest rate hikes by the Reserve Bank of India and the US Federal Reserve (Fed) also increased the appetite for risk-prone assets.

“The good news was that the Fed’s actions showed signs of progress, as inflation in the US peaked and slowly receded heading into 2023. Investors have accentuated this mildly positive news and bid down longer-term rates to effectively invert the yield curve and show a general expectation of Fed rate cuts in the coming quarters — presumably to counteract a slowing and potentially recessionary economy. These expectations — whether presumptuous or not — have helped fuel a mild reduction in longer-term rates and reinvigorated investor appetite for stocks and quality bonds,” observes Robert Jenkins, global head-research, Lipper.

The first half of CY23 has been particularly good for the US and Japanese stocks. The technology (tech)-heavy Nasdaq has risen nearly 30 per cent, while the S&P 500 gained 14 per cent. Also, Taiwan and South Korea rose nearly 20 per cent and 15 per cent, respectively, as the theme around investing in new-age tech picked up steam globally. The Japanese markets were also a standout performer, with the Nikkei 225 gaining 27 per cent to its highest level in nearly 33 years.

In effect, the returns generated by the domestic markets paled in comparison to some of their global counterparts. Analysts say returns during the second half of the year could moderate after a sharp bounce from lows. The Nifty has bounced back 12 per cent off 2023 lows. 

The Nifty Smallcap 100 surged 24 per cent; the Nifty Midcap 100 rose 21 per cent. In a note this week, CLSA, which runs a 40 per cent ‘overweight’ stance on the Indian market, has sounded a note of caution.

“We remain cautious for now, given the exceedingly rich valuations, margin erosion depleting India’s relative profitability, consensus earnings per share growth expectations remaining too optimistic (certainly versus the delivered track record), the Reserve Bank of India likely lagging emerging market central banks in the timing and scale of policy easing, and our econometric model signalling the market is 14 per cent overbought,” it said.

Some believe the general elections in May 2024 could also put a lid on further upside.

“There are going to be further hikes in the US. We are running into the general elections, and there will be a series of state elections before it. A year before the central election is not good for the markets,” says Bhat.

Chokkalingam G, founder, Equinomics Research & Advisory, says the immediate headwind for markets will be the monsoon. 

“If the monsoon does not pick up in the next three weeks, inflation will start rising, and rate hikes will be back. Our market capitalisation is at a new high now. We are not in a position to stand any negative disruptions,” adds Chokkalingam.