Foreign flows would take some time to improve: IIFL Asset Management

Due to increased uncertainty surrounding global macro factors, Indian equity market may experience volatility in the short term. Although the recent crisis in certain US regional banks has prompted the Fed to reconsider its hawkish stance, the central bank may still focus on managing inflation over the medium term and continue the interest rate hikes.

In India, a major concern is the historically-low interest rate differential between India and the US despite similar worries about inflation. Surprisingly, the RBI took a pause and kept the policy rates unchanged in the latest policy meet, but reiterated its commitment to curb inflation. We believe that the RBI would have to resume rate hikes and continue with withdrawal of easing measures to prevent significant depreciation of rupee caused by capital outflows.

The BSE Sensex is trading at around 3.3x price to book, which implies a small premium to its 20-year historic mean. Hence, there could be some downside in the short term driven by resumption of interest rate hikes, tighter liquidity and currency depreciation worries. However, from a medium-term perspective, the fundamental outlook seems attractive as the investment cycle is in the early stages of recovery.

Foreign flows are driven by attractive rates, stable currency, stronger economic growth and political stability. While India scores extremely well on the growth outlook, domestic yields are becoming less attractive compared with developed markets such as the US.

The RBI’s decision to keep rates unchanged while the US Fed continues to raise rates could have a negative impact on the flow of capital. We think foreign flows would take some time to improve. The currency outlook needs to stabilise for which domestic rates would need to become more attractive compared to dollar-denominated instruments.

The value of equity capital raised on a rolling six-month basis, has more than halved from the levels seen a year ago. To enhance activity levels in the primary market, markets need to demonstrate more resilience. However, the near term looks quite uncertain and we need to tangibly enter the declining rates and improving growth environment to fuel an upswing in the primary market. 

Based on a price-to-book (PB) valuation, it appears that the NSE mid-cap index is currently trading at a discount of approximately 9 per cent in comparison to the PB of the Nifty, which is lower than the 10-year average of 17 per cent. Similarly, the NSE small-cap index is trading at a discount of 14 per cent compared with the Nifty, which is significantly lower than the 10-year historical mean of 52 per cent.

Therefore, from a top-down perspective, there is no compelling case for these indices over Nifty. Instead, we prefer adopting a bottom-up approach to stock selection at this point in time. 

We are optimistic about the investment cycle, and thus, domestic cyclicals such as financials, autos and industrials are well-positioned in this environment. There are certain interesting themes, which are set to play out well over the medium term.

Pick-up in capex cycle and rising penetration of electric vehicles are interesting themes from the medium-term perspective. We are quite bullish on the EV theme and have been investing in companies that can benefit from it. The capex cycle has been in a consolidation phase for almost a decade, but now it seems poised for a pick-up.

Several factors are contributing to this trend, including the strong balance sheets of banks that can support growth in capital expenditures, government policies such as the Production-Linked Incentive (PLI) scheme, and the China+1 phenomenon. In the automobile sector, EVs are still in the early stages of adoption in India. However, we are optimistic about their potential in the country and consider them to be an important factor when evaluating investment opportunities in the sector.