Insights

The Nifty declined 2% in December but gained 8.8% in CY2024. Mid-cap and small-cap Indices outperformed the large-cap index and were up 1.4% and 0.6% in December and 23.9% each in CY2024. Sector-wise, healthcare and realty were the best-performing sectors in the month of December while Power, metals and PSU indices declined 7%, 5.4% and 5.2% respectively in December. Global markets showed mixed trends as Japan (+4.4%), Taiwan (+3.5%) and Hong Kong (+3.3%) were the major gainers, whereas the US Dow Jones, Brazil and US SPX declined 5.2%, 4.3% and 2.4%, respectively. Other key developments during the month: (1) the RBI kept the repo rate unchanged at 6.5%, cut CRR by 50 bps, (2) the US Fed cut the interest rate by 25 bps and indicated fewer rate cuts next year, (3) Japan’s cabinet approved a record budget of US$732 bn for the next fiscal year. FPIs bought US$ 1.8 bn of Indian equities in the secondary market, whereas DIIs bought US$4 bn.

High-frequency data for Dec suggest a mixed trend. Power demand rose to a five-month high of 5.9% in Dec (partially due to a low base). PMIs for manufacturing softened to a 12-month low of 56.4 while services PMI rose to a 4-month high of 59.3 in Dec. Credit growth improved to 11.5% YoY as of Dec 13 from 10.6% in the previous fortnight. Vehicle registrations for two wheelers were weaker in Dec on a YoY basis, but higher for passenger vehicles. Naukri Job Index picked up pace both on a YoY and sequential basis, with recovery in hiring activity across the board. Domestic Air passenger traffic growth in December was strong. (+11.6% yoy)

Last year same time, when we put out our market prognosis for 2024, we expected a front-ended rally with much of the market returns coming about in the first half of that year. As we try to look ahead into 2025, we expect exactly the converse of 2024, i.e. back-ended returns with some of the weak trends of the economy and the market seen during 2H2024 spilling into 2025 as well. The slowing public expenditure both central and state, during 1HFY25, has not seen much improvement in 3Q and remains a key monitorable for the remainder of this year. Early trends once again foretell a muted growth for 3QFY25 which in turn is raising nervousness on street estimates for FY26 as well. While we continue to hold out hope that 2025 will start seeing benefits of slowing inflation helped by a better crop outcome, long-awaited rate cuts and improved rural consumption, we may have to contend with some of the weak trends to prevail in the early part of the year thereby resulting in subdued market conditions during this period. In this backdrop, we reckon govt/central bank policy actions to accelerate system growth will have a crucial role to play in the eventual recovery of economic growth and earnings for 2025. While equity market has corrected anywhere about 10pc from peak, primarily reflecting the earnings downgrades, we expect markets to move in a narrow range over the next few months as it waits to ascertain if the recent slowdown is transitory or more deeply entrenched.

Meanwhile, the US markets are likely to witness strength on the back of potential earnings upgrades driven by Trump tax cuts and tariff barriers. We expect this to continue into early part of 2025 till the new govt assumes office and new policies take effect. We see likelihood of emerging markets, including India, to underperform relative to global markets in 1H2025 but with a high probability that the cycle could subsequently reverse in the latter half of the year.

The ongoing market correction in India should help moderate valuations particularly relative to global markets and in the process provide entry opportunities for long-term investors. We hold to the view that India markets would largely undergo an earnings-led cyclical correction if any. Keeping the overall macro-profile and top-down narrative in focus, we see low probability of a valuation compression driven deep correction in the market. We continue to expect opportunities in the broader space of mid and small caps with too, but execution and delivery will be at a premium here and market will likely be more discerning on the choice of companies. Overall, risk management will be extremely critical for 2025 noting overall strong returns of the market in the last couple of years. Intermittent corrections, especially those caused by global factors that provide attractive valuation-based entry points, should be used by investors to accelerate investments and enhance overall return outcomes.

US treasury yields hardened sharply by ~40-45 bps & Dollar index surged to 108.49 from 106.45 as market moderated US rate cut expectations on healthy economy and Trump’s policy fears. Notwithstanding, domestic yields exhibited resilience as 10 yr G-Sec hardened by ~5 bps only and largely remained range bound. However, INR got impacted relatively more as it quickly depreciated against USD to 85.61 from 84.70. Banking liquidity turned deficit towards end of month, resulting into a sharp rise in short end yields.

Outlook

Year 2025 brings an element of global volatility as Mr. Trump takes Presidential office in Jan 2025 and implement his policies of higher import tariffs, bigger fiscal spends, corporate tax cuts and anti-immigration rules. Some of these policies may have a potential of shortening US rate cut cycle, raising volatility in global financial market and more so – currency pressure for the Emerging Market (EM) countries. We believe US’s FOMC will maintain a data-dependent approach and find room for further rate cuts within its dual mandate of price stability and maximum employment.

Against the global uncertainty, Indian fixed income market is expected to remain largely insulated on the back of strong fundamental factors, similar to the divergence exhibited in Year 2024. MPC in its previous two policies has started easing out already, first with a policy stance change and then with a 50 bps CRR cut. Feb 2025 will be a live policy as growth may surprise on the downside and headline inflation is further expected to moderate in FY26, driven by receding food inflation. First advance estimates released by the National Statistics Office pegs FY25 GDP growth at 6.4% against RBI’s projections of already truncated 6.6%. RBI has projected 4% inflation in 2QFY26 and we expect RBI in its Feb 2025 policy to project close to 4% inflation for FY26. This growth-inflation dynamics can open room for MPC to deliver its first rate cut in Feb 2025, though we expect a shallow rate cut cycle of 50-75 bps. Risk to our view may emanate more from global front if US policies create elevated volatility in currency market which can force the Central banks to turn hawkish to protect their currencies.

Fiscal demand-supply dynamics to stay favorable for yet another year & remains the most comforting factor. India continues to enjoy the benefit of a fast-paced fiscal consolidation and strong domestic as well as foreign investor’s demand. For FY25, Govt is expected to achieve a better fiscal deficit of 4.7% - 4.8% against the budgeted 4.9% on healthy tax collections and lesser than budgeted Capex spend. We expect Govt to budget 4.4% - 4.5% fiscal deficit for FY26 with continued focus on Capex and few additional measures to boost domestic consumption.

Banking liquidity has remained deficit in first week of Jan 2025 even after Govt’s month end spending and is expected to remain tight over next few months as currency in circulation increases seasonally and as foreign capital inflow remain volatile amidst global uncertainty. RBI has been actively providing liquidity at ~6.52% through Variable Repo Rate, nonetheless, short end yield curve is expected to remain elevated.

Overall, risk-reward remains favorable at current juncture as healthy domestic demand-supply dynamics & expected rate cuts will help in bringing the market yields down and produce capital gains. Current yield curve is elevated amidst recent global spillovers & also tight domestic liquidity which provides an entry opportunity for investors across the yield curve. For instance, one yr bank’s CD yield at ~7.70% vs one year forward looking inflation at 4.2% - 4.4% provides ~340-350 bps real returns. It will be critical to position appropriately on G-Sec & Corporate bonds yield curve. G-Sec yield curve is steep and is expected to flatten with long end yields coming lower on robust demand from investors like insurance companies, NPS, EPFO in last quarter of a financial year. Corporate bond yield curve on the other hand, is inverted and is also expected to flatten but with short end 1- 5 yr yields coming lower more rapidly. Any uptick in yields due to still evolving global factors should be seen as an opportunity to build further exposure as the rate cut cycle commensurate over next few months. Active fund management is critical as uncertainties may emanate from domestic inflation and global backdrop which may influence various yield curve segments differently.