India has successfully decoupled from the rest of the world as major global (other than domestic) stock indices and economic indicators failed to positively surprise the upside as we usher in the New Year 2023. While there was a hiatus seen in November 2022 (after months of relentless selling in benchmark US and European indices since the cycle started reversing in November 2021), it would be too early to categorize this as a robust buying backed by strong forward-looking fundamental indicators. That said, the valuations of global indices look too attractive compared to that of India.
India clocked in a GDP growth rate of 6.3% and a GVA print of 5.6% for Q2 of FY23 as per the data released by the finance ministry on Wednesday. The real value added (GVA) moderated to 5.6% from 12.8% in Q1 of FY23 and the reason behind this was a fall in industries, mainly the contraction in the manufacturing sector. While there is a base effect component involved, it would be premature to conclude that India deserves an earning multiple of 23 compared to the mid-teen P/E ratio of global stock indices.
On 1st December 2022, India posted an 11% rise in year-on-year GST collections, marking yet another month of double-digit growth in indirect tax collections. 9th straight month where GST collections have stayed above 1.40 lakh crore! This figure is in sync with the trends seen in the GVA growth of Q2 FY23 with growth trends moderating in household consumption. Adjusted for inflation, the real growth looks muted. 
The 3rd and 4th quarters of the current financial year look promising on the back of higher festive season spending, a rise in private and public capital expenditure, and a likely moderation of inflation.
The Brighter Side of 2023
Strong Growth and Decelerating Inflation
October 2022 showed the first signs of inflation moderation as the CPI print came in below 7% for the first time compared to the preceding 3 months. Moreover, the RBI is unlikely to revert to an accommodative stance due to the positive output gap. However, the CPI basket is yet to depict a sustained deceleration. For it to fall between the targeted range of 2% to 6%, the RBI is expected to remain hawkish even after 190 bps in rate hikes this year. This hawkish policy will eventually ensure that inflation stays within the target range. More clarity will emerge in the upcoming monetary policy committee meeting to be held between the 5th to 7th of December 2022.
Additionally, the base effect of high inflation this year is expected to result in low inflation in 2023, assuming there isn’t any black swan event that might give rise to extreme situations.
On the growth front, while private CAPEX has been lagging the capital expenditure by states and central government, 2023 could see a comeback of the private sector with corporate profitability increasing on the back of multiple triggers.
The government coffers have witnessed an unprecedented rise in revenues. The direct and indirect tax collections have grown in double digits post-Covid-19. Public sector enterprises including PSU banks have shown tremendous improvement in their core operational performance. Due to this, the government has rescued itself from bank recapitalizations and injecting taxpayer money into debt-ridden and loss-making PSUs. The money that is saved due to this, is moved to CAPEX, generating more jobs and in turn increasing household consumption.
Falling input / raw material prices
September quarter earnings of India Inc (ex Banking and Financial Services) were subdued due to the soaring commodity prices that peaked in June 2022 in the aftermath of the Russia-Ukraine war. While the economy showed strength as net sales of domestic companies grew by approximately 25-30%, the EBITDA declined by 8.3% and the overall profitability fell by 24%.
Generally, the companies order the raw materials in advance, and therefore the muted earnings were a result of the inventory that they were carrying. The 3rd and 4th quarters are expected to showcase a sequential rebound as the input costs have fallen, except for Crude Oil which continues to hover around USD 90/barrel.
Fed’s stance on inflation
The United States has witnessed a massive increase in interest rates, levels that were last seen before 2008. While the Fed could continue to raise rates in order to stabilize the macroeconomic environment and bring down the inflation rate, the pace at which the rates were increased in the last 6 months is expected to slow down. That said, Federal Reserve Chair Jerome Powell has signaled to the American people that the borrowing costs would continue to remain elevated until the inflation rate falls between 2% - 3%.
Risks: What could spoil the party?
Russia-Ukraine War
The tensions between Russia and Ukraine continue to rise as the latter remains under attack with a shortfall in necessities such as food, power, shelter, gas, etc. The Ukrainians continue to suffer and shiver in dark, cold houses, with many using camping stoves to cook food. Engineers are working round the clock to restore electricity with minimal support. Nobody knows how and when the war would end but it has already caused enough destruction with both sides failing to reach any consensus. This remains the biggest risk to the global fraternity and India as well. The commodity prices could continue to swing in either direction causing difficulties for central bankers in finding a middle path to stabilize the broader economy.
Valuations
India continues to demand premium valuations as against its global peers in the emerging economies category. Factors such as reversal in raw material prices, declining unemployment, and increase in demand and consumption, have led to a sustainable and persistent upliftment of India’s economic indicators and benchmark stock market indices.
However, historically, such premium valuations haven’t been sustained and the stock markets have generated flat to negative returns in such situations. While India should cheer as the benchmark indices touch new highs amidst all the global uncertainties, it makes sense to remain utmost cautious as the euphoria builds in.
As India ushers in the golden era, one should not forget that all the known good things (opportunities) and the known not-so-good things (risks) have been factored in. What remains to be seen are the black swan events that could shape the future of the Indian economy and the Indian stock markets. Nobody expected Covid-19 and its detrimental effects, not many predicted the post-pandemic boom in the hospitality industry and the secular trends that emerged thereafter. Nobody managed to envisage the boom in commodity prices due to the war, and in the same way, it is going to be difficult for analysts to predict how the future holds. As of now, everything is in hindsight!
State Assembly and General Elections
The consensus as of December 2022 is that there will be stability and continuance of majority governments in the state and in the Centre (in Lok Sabha elections 2024). That said, a consensus has always proven to be dangerous and that risk continues to remain at the top of the list. An unclear mandate in key state elections could derail the economic progress that India has achieved in the last few years. Governments could resort to increasing subsidies as a result of fear of losing elections. The strategic disinvestment and privatization plans could take a backseat and thus lead to fiscal imbalance.
Amidst all the uncertainties, what are the best investment strategies for 2023?
- Premium equity valuations generally result in flat to negative returns in the short to medium term. Therefore, an optimal asset allocation model could play a major role in formulating return expectations and risk management
- Team Tavaga believes that equity as an asset class should continue to do well in 2023 but the index could be range-bound. Sticking to stock-specific ideas could play out well for equity investors
- For investors with surplus capital, money can be parked in a liquid fund or an arbitrage fund with an STP in equity-oriented schemes (mostly passive for large-cap and active for mid-cap and small-cap or a flexicap fund)
- Fixed-income investing should be focused upon as the interest rates have increased substantially. Also, the equity investment pockets continue to remain limited. The yields of target maturity funds have considerably risen, thus offering a lower NAV as compared to last year.
While equities can continue to generate inflation-beating returns, a tweak in the asset allocation model favoring more lumpsum fixed-income investments and only sticking to SIPs/STPs in equity funds can play out well for retail as well as HNI investors. Moreover, keeping idle funds in a savings account could prove to be a major drag. The yields on short-term treasury instruments have risen from 2.70% in May 2020 to 6.60% in December 2022.
There are no signs of a bearish phase but it’s time to remain cautious as the IPO season has made a comeback, fund managers have started launching funds, and retail investors are demanding multi-bagger returns in a short time horizon.