We expect a catch-up trade in Indian equities, says Prakash Kacholia

US payroll numbers released recently point to Goldilocks scenario: unemployment at 53-year low, and yet moderating wage gains, says Prakash Kacholia, MD, Emkay Global Financial Services

It has been a rough ride for the markets so far. Prakash Kacholia, managing director at Emkay Global Financial Services, in conversation with Puneet Wadhwa, says neither the domestic investors nor foreign ones have the muscle to take the market forward if the fundamentals don’t support it. Edited excerpts:

Have global markets fully discounted the negatives of a recession and what the central banks may do to revive growth?

The developed and emerging markets (EMs) have rebounded strongly since October lows, as growth has held up relatively well, even as inflation has moderated significantly.

The US payroll numbers released recently point to a Goldilocks scenario: explosive non-farm payrolls, unemployment at a 53-year low, and yet moderating wage gains. The base scenario now appears that the US can indeed have a soft landing or a very mild recession. Central banks will continue to sound hawkish, which the markets will mostly ignore.

Is the risk/reward favourable for investing in small- and mid-caps at current levels?

Small- and mid-cap valuations are off their peak – both in absolute and relative terms. We expect the benefits of cooling input prices and second-order benefits of a wider capital expenditure cycle to drive stronger earnings growth for mid-caps than for large-caps, which are dominated by the financial sector.

While small- and mid-cap opportunities are best-analysed bottoms up, we see a very constructive tailwind from China Plus One, successful production-linked incentive templates, a better credit ecosystem, and sensible capital allocation.

Have developments related to Adani Group dented India’s appeal in the eyes of foreign investors as far as regulatory norms are concerned?

While the allegations against Adani Group have impacted market sentiment, its medium-term implications are unlikely to be significant.

The market needs to differentiate between exuberant valuations – which almost always correct with a bang – and the underlying legitimate and profitable businesses. While we are not forensic accountants, almost all major assets of Adani Group are in ports, airports, power and transmission, and roads, where returns are regulated and unit numbers are reported to various regulatory bodies.

Profitability metrics are not a significant deviation from their peers, but valuations are. It’s nevertheless important that the group takes steps to restore investor confidence.

Foreign flows, most experts think, will find their way into China as its economy reopens for business. How do you think it will impact other Asian markets?

Since October 2022, Chinese markets are up a staggering 50 per cent after an abrupt change to their zero Covid policy. The relative catch-up game has already played out. Indeed, the structural problems of property overbuilding, an ageing workforce, and a non-democratic establishment remain.

Meanwhile, India’s relative premium to EMs has corrected, although it is still above its historical average. We expect a catch-up trade in Indian equities, especially after a market-friendly Budget.

Do you think domestic institutions and retail investors have the muscle to hold the markets at current levels, and possibly take them higher?

Neither the domestic investors nor foreign ones have the muscle to take the market forward if fundamentals don’t support it. We need to differentiate between cause and impact. The underlying factor is always earnings and the interest-rate trajectory.

We may not realise this, but India’s macroeconomic indicators have seen a significant turnaround over the past decade, with controlled inflation, modest rupee depreciation, and steady growth serving to reduce the equity risk premium. This accelerates savings into equity markets.

Are companies now looking at alternative fundraising sources rather than tapping into equity markets or looking at listing, given the secondary-market volatility?

There could be near-term slack in equity fundraise with higher equity volatility. We don’t see anything more than an aberration, which will correct over the next few quarters.

The Securities and Exchange Board of India has also taken several regulatory steps that have democratised the initial public offer process, which, in turn, has rationalised the valuation expectations of promoters.

Listing gains are close to the issue price now, which is how they should be for the healthy functioning of markets.

What is your assessment of corporate earnings growth in 2023-24 (FY24)?

We expect 15 per cent earnings growth for the Nifty50 companies and 24 per cent growth for the mid-cap index in FY24. For mid-caps, we expect 25 per cent compound annual growth earnings through 2024-25, with margin expansion in automotive and consumer goods, which are the standout sectors.

Do you see margin pressure for the broking industry?

A number of new regulations that come out every week and the cost of compliance are on rapid rise. The broking business, on the whole, has also become very capital-intensive, putting pressure on net margins.