Robust domestic flows, primarily through MFs, but also direct stock purchases, insurance and pension funds flowing into equities.
But impact of both these factors is waning. This implies that return expectations over 2025 need to be moderated to about 10%, with a possibility of undershooting in H1 2025.
After a long wait of 8 years (after peaking out in 2012), investment upcycles began in 2021. 2025 would be the fifth year of those. Investment upcycles are characterised by a rising share of investments (as % of GDP) and a boom in housing and infra construction and corporates expanding manufacturing. These drive job creation and higher economic growth. Investment cycles are long and usually go on for 8-10 years. So, we have another minimum 3-5 years to go.
The driver of the cycle is moving away from government to private sector. An upturn in India’s capex cycle started in late-2020, led by housing and a push from GoI towards infra spending. After rising 3x over five years, government capex is slowing. Growth should be in line with nominal GDP (10%) or lower, as incremental populist spending is on the rise.The housing cycle is still strong, with inventories near 14-year lows. Private capex is also rising, with strong corporate balance sheets and opportunities in power, electrification, PLI schemes and building materials driving spending. Overall, capex uptick is expected to support 6.5-7% GDP growth in 2025.A shallow slowdown is expected to be over by H1 CY25. Economic activity levels slowed during 2024 because elections in Q2 CY24 slowed government spending, and disruptive rainfall and festive season impacted activity in Q3. Moreover, a regulatory-driven 5 ppt slowdown in credit growth also impacted economic growth and consumption.
An expected pickup in government spending early in the year, improved liquidity and a lower base of activity later should imply a pickup in GDP growth. This will also come as a relief for corporate earnings.
The 21% earnings CAGR over FY21-24 has moderated to 10% in FY25E. Drag from aggressive fiscal consolidation and a 5 ppt contraction in regulatory-driven credit growth has led analysts to cut their estimates. With these drags in base and government spending supporting consumption, earnings growth should improve to 13% in FY26E. This builds in a 2-3 ppts downgrade from the current bottom-up expectation of 15%.
The second factor supporting stock markets has been large domestic equity demand, even as FPIs have been small net sellers in 2024. Currently, domestic equity demand has touched about $100 bn during CY24. This is nearly 3.5x domestic flows seen in CY23.
But with such a big increase in equity flows, households are channelling 20%+ of financial savings into equity markets. This is a large number, and is now comparable to certain developed markets like Britain, which has much higher income levels and risk appetite. An average Indian household has much smaller savings and risk appetite, and a potential correction or low return phase in the equity market may drive households to invest less in equity markets.
While there’s a possibility of domestic flows slowing down, equity paper supply (IPOs, qualified institutional placement, promoter, and PE block deals) has increased. Equity supply has jumped to a record $60 bn over 9M CY24. The supply accelerated in H2 as a few large IPOs (Hyundai, NTPC Green, Swiggy) added to the ongoing QIP/block supply.
At $7 bn/month over Jul-Nov 2024, supply has caught up with equity demand from domestics, and markets have been flat in H2. Equity supply should stay elevated, unless the market corrects. This supply factor has now fully negated the positive of strong domestic flows. FPI flows (extremely weak in CY24) are showing signs of catching up and likely acting as a cushion.
Investors in equity markets need to prepare for much lower returns in CY25, with a likely bumpy ride. The possibility of further short-term capital gains tax increases, which could impact investor sentiments, can’t be ruled out. Large caps are preferable over mid/smallcaps going into 2025, with large banks and financials as the best bet.
The writer is MD & head of research, Jefferies India