Indian equities witnessed bouts of volatility in February but ended the month higher with the Nifty 50 touching all-time highs. The S&P BSE Sensex ended 1.2% higher and the NIFTY 50 was up 1.5%. Mid-caps and small caps were subdued to some extent than the frontline indices and both the NIFTY Midcap 100 & NIFTY Small cap 100 ended the month nearly unchanged. Market breadth was weak as indicated by the 13% decrease in the advance/decline ratio (down 13%) while volatility was lower compared to the previous month.

Bond markets were driven by the outlook for the US economy as higher inflation, low consumer confidence and pushed back expectations of interest rate cuts. Consequently, yields on US Treasuries rose over the month on tempered rate expectations. In contrast, Indian government bond yields fell for the fourth consecutive month, trading in a narrow band of 7.05-7.15% and ending at 7.08%. Another factor that helped subdue yields was the Foreign Portfolio Investors (FPI) flows into government bonds ahead of India's inclusion in the JP Morgan indices. FPI's were buyers of debt to the tune of US$2.7 bn (the highest in over six years).

Key Market Events

► Global interest rate environment: US Treasury yields further rose over the month as higher than expected headline inflation led investors toshift expectations of interest rates cuts from March to May/June. The yields on the 10-year benchmark Treasuries rose 34 bps in February while the yields on the 2-year Treasuries ended 41 bps up at 4.62%. The European Central Bank (ECB) is also projected to lower rates in June with inflation declining and economic growth stagnant while the Bank of England could be the last of the central banks in the developed markers to lower interest rates. Meanwhile, the Reserve Bank of India (RBI) left its interest rates unchanged and revised its GDP forecasts.

In Japan, expectations are increasing for the Bank of Japan to end its eight year stretch of negative interest rates in April along with its yield curve policy. In China, investor confidence was boosted due to a series of government measures aimed at supporting both the economy and financial markets. This included a 25 basis point reduction in the 5-year Loan Prime Rate, which serves as the benchmark interest rate for mortgage loans.

► Inflationary pressures cool while oil prices heat up: CPI slowed to 5.1% in January, vs 5.7% in December, while core CPI moderated further to 3.6%. The decline was led by a moderation in food prices increased, especially vegetables. The government's proactive supply-side management and progress on rabi sowing will provide some degree of comfort. Meanwhile, oil prices stayed above the 80-mark for most part of February amid uncertainty over the prospects of a ceasefire between Israel - Hamas leading to higher shipping costs.

► Economic growth buoyant, macro steady: GDP growth improved to 8.4% in Q4FY24 as against the 8.1% seen in the previous quarter, led by a sharp increase in net indirect taxes. GVA which adds up production (across agriculture, industry and services) grew by 6.5% vs 7.7% in the previous quarter. Data pointed out to improving consumption albeit at a slower pace and robust trend in capex. Additionally, GDP numbers were revised for the previous two years which also impacted growth due to base effect. Nominal growth for the quarter stood at 10.1%. Most monthly high frequency indicators remain robust. Private consumption (especially rural consumption) continues to remain weak and is a concern as it is much weaker than overall GDP growth. Meanwhile, RBI has upped its growth projection to 7.0% for FY24 (also projected 7.0% for FY25) due to strong growth in the first half of FY24.

Market View

Equity Markets
The Q3FY24 earnings season has concluded, and the earnings growth trend remained intact, with margins expanding for the fourth consecutive quarter. Broad market earnings outperformed the narrow market. With markets at or near all-time highs, investors should be cautious of potential volatility in the near term. Valuations in India are expensive relative to the Asian peers and India remains the most expensive market (on both forward P/E and trailing P/B basis). Mid-caps and small caps have experienced a sharp run, so a rotation into large caps may be warranted. Investors should focus on the long term rather than making short term decisions. We are almost heading into elections in the next two months and that could set the tone for the markets in the near term.

Nonetheless, the positive long-term drivers remain in place. We believe India is on a higher growth trajectory and continues to be one of the few geographies globally that continues to record strong GDP growth. Macro indicators suggest that India's twin deficits (current account and fiscal) as well the currency are under control. Inflation although uneven over the past few months is expected to head lower as reiterated by the Reserve Bank of India. Economic growth remains strong, as evidenced by the headline GDP print of 8.4% in Q3FY24. There have been positive revisions to the H1FY24 data as well. This growth was driven by capex. Construction was the fastest-growing component, while consumption within the rural economy was weak.

We believe India's capex cycle is expected to receive a boost from increased government spending and an upturn in the real estate market. Corporate balance sheets are healthy, providing a foundation for a private capex cycle. As widely expected, the RBI kept interest rates on hold and is expected to lower them in the second half of the year, which should benefit rate-sensitive segments. In the near term, slowing growth in developed economies could exert pressure on external demand, acting as a drag on exports.

We anticipate that market dynamics will be influenced by favorable cyclical factors and capex-driven segments such as infrastructure, domestic oriented manufacturing, and utilities should benefit. Our portfolios are positioned accordingly and we are overweight these segments. We are also optimistic and overweight consumer discretionary sector, particularly automobiles and real estate. We also have exposure to sectors such as power, defense, and transportation that could benefit from government policies. As companies seek financing for expansion and new projects, banks are likely to see an increase in credit demand, which should bolster their performance. In the pharmaceutical sector, the upcycle in the US generics market is still young, and we expect the improved pricing environment to continue and strengthen. We are underweight in the exports segment due to slowing global growth.

Debt Markets
InflationInflation prints came higher than expected across economies, however, inflation is slowing down overall. Following Fed speak in late January, investors have pushed back expectations of rate cuts to April-June 2024 which aligns with our view on the US. We do believe that the ECB will also look at lowering interest rates around the same time as the Fed. We do believe that from here yields could have a limited upside as interest rate cuts are definitely on the cards. Even our central bank could take cues from the central banks of the US and Europe. Furthermore, RBI may want to lower interest rates after the elections are over.

Concurrent to our view, the RBI retained a pause on interest rates for the sixth consecutive policy. The governor highlighted uncertainty around inflationary pressures in the near term, and added that the RBI was mindful of it and expected it to fall lower to 4% by Q2FY25. We had expected a change in liquidity stance which did not materialize. Nonetheless, as RBI mentioned, we do believe the central bank will effectively utilize liquidity management tools. The RBI is comfortable with the inflation trajectory and has revised its growth targets. With policy rates remaining incrementally stable, we remain long duration across our portfolios within the respective scheme mandates. The path of fiscal consolidation, demand supply dynamics in government bonds, a benign global environment and expectations of falling interest rates in the US, Europe and in India make an interesting theme for a long duration stance for investors.

Most part of the fixed income curve is pricing in cuts only after June 2024 and this goes well with our house view. With policy rates remaining incrementally stable, we have retained our long duration stance across our portfolios within the respective scheme mandates. We do expect the 10-year bond yields to soften to 6.75% over the next few months.

From a strategy perspective, while the overall call is to play a falling interest rate cycle over the next 6-12 months, markets are likely to see sporadic rate movements. From a strategy perspective, we continue to add duration across portfolios within the respective investment mandates. Investors could use this opportunity to top up on duration products with a structural allocation to short and medium duration funds and a tactical play on Gilt funds.

Source: Bloomberg, Axis MF Research.