Do it yourself

Capital expenditure (capex) has been one of the primary focus areas of the government in the past one decade. As per the Economic Survey 2024, “The focus of capex has been broad-based. Spending in sectors such as road transport and highways, railways, defense services, and telecommunications delivers higher and longer impetuses to growth by addressing logistical bottlenecks and expanding productive capacities. Government capex has also begun to crowd in private investment, as discussed earlier in this chapter. Additionally, the Government continues to disburse grants-in-aid for the creation of capital assets to the states, thereby incentivizing them to increase their productive spending.”

Accordingly, “capex” has emerged as an important driver of growth, as indicated in its rising share of nominal GDP. As per the provisional actual (PA) figures for the FY24, capex for FY24 stood at ₹9.5 lakh crore, an increase of 28.2 per cent on a YoY basis, and was 2.8 times the level of FY20.

However, despite the sharp rise in the government capex in building the enabling infrastructure and incentivizing enterprises, the private capex has not responded adequately. Lamenting the private entrepreneurs, the Economic Survey stated, “while it remains the government’s responsibility to facilitate the development of infrastructure and address logistical challenges, it is incumbent upon the private sector to take forward the momentum in capital formation on its own and in partnership with the Government. Between FY19 and FY23, the share of private non-financial corporations in overall GFCF increased only by 0.8 percentage points from 34.1 per cent to 34.9 per cent. This was mostly driven by their fast-increasing share in the additional stock of dwellings, other buildings and structures. Their share in addition to the capital stock in terms of machinery and equipment, started growing robustly only since FY22, a trend that needs to be sustained on the strength of their improving bottom-line and balance sheets in order to generate high-quality jobs.”

In the recently concluded general elections, lack of adequate job generation emerged as one of the key agenda points. The experts have held the prevalence of high unemployment rates amongst educated youth as one of the factors responsible for below par performance of the BJP.

Obviously, the government is concerned about the employment situation. The problem is that commitment to fiscal discipline and structural reform in the public sector may not permit the government to create many new employment opportunities in the public sector. The employment generation would thus be the responsibility of the private sector.

In the recent budget for FY25, the government announced some measures to encourage private enterprises to invest in building new manufacturing capacities and generate employment for the youth entering the job market. The budget adopts a carrot and stick approach for that. On one hand, it provides support for hiring more fresher employees and skill them, and on the other hand it makes outflow of funds from companies difficult. After dividends, now buybacks are also made tax inefficient. The idea seems to “encourage” companies to invest in growing their businesses and reward shareholders through share price appreciation only. Abolition of Angel Tax on startups is also a measure to encourage more new businesses to be set up and offer employment opportunities.

How much of these efforts will yield in terms of new employment and growth is to be seen, but the intent seems clear.

After a decade, the price of his plot is up by some 300%. He is happy that he made a very good investment decision.

When I pointed out to him that Dehradun is no longer the peaceful, clean and cheap city it used to be ten years ago. Therefore, his investment premise has mostly failed. Besides, the land prices in many areas of the NCR have risen equal to or more than Dehradun in the past one decade.

The point to ponder over is if you earn a good return on your investment in spite of your assumptions behind making such investment proving to be wrong or inadequate – would you consider yourself to be an astute investor, even eligible to advise others, or just plain lucky!

To emphasize my point further, let me give you some more pertinent examples.

In December of 2023, many investment advisors advised their clients to invest in long duration bond funds. The primary premise underlying their advice was that the US Fed shall start cutting rates from February and the RBI shall follow the suit.

However, seven months later, neither the US Fed nor RBI have cut rates. The visibility of a material rate cut in 2024 has diminished considerably. The US benchmark 10yr yields are higher by 15bps YTD. Regardless, the benchmark yields in India are lower by 20bps. Long duration bond funds have, on average, yielded a very good return of ~7% YTD.

You tell me, if the investors who invested money in long duration bonds were smart or plain lucky?

Extrapolating this to equities, at the beginning of the year 2024, most brokerages projected an earnings growth of 17-20% for FY25-FY26. They expected buoyancy in capex, especially private capex. Massive growth was projected for the sectors like Railways, Defense, Power, Banks and Construction (especially roads). IT Services was forecasted to be the worst sector for 2024, in terms of earnings growth. Commensurate with these projections, ambitious price targets were set for industrials and infra builders.

After six months, the actual performance earnings and order flows are at divergence from the analysts’ projections. The 300 odd companies that have declared results for the 1QFY25 so far, have reported an average profit growth of less than 5% and sales growth of ~10%. IT Services companies have performed reasonably well. New project awards for roads and other infrastructure projects are much below projections. Power, Defense and railways sector companies have reported below par results. The Economic Survey has expressed concern over the private sector’s muted response to the government incentives and not doing enough capex in manufacturing capacities. Regardless, the stocks of these companies have recorded stupendous gains.

One defense sector fund has yielded return in excess of 115% in the past one year. My point again is whether these investors are plain lucky to have earned good return on their investments or they planned their success?

Also, the advisors, fund managers and analysts who made wrong assumptions but nonetheless performed well on returns deserve the credit for their performance or need to be questioned for their poor analysis?

In my view, Luck cannot be the primary factor in an investment plan. A good investment plan shall focus more on the process, fundamentals and accuracy of the assumptions rather than the price action, in the near term.

Remember, when the “experts” run out of luck, they would hide behind the excuse of “mean reversion” for their poor performance. As an investor you may not have that luxury.

I had posted my first impression of the Union Budget FY25 on Tuesday. On a second reading of the budget documents and listening to the views of a variety of experts, I have gathered some more inputs that I would like to share with the readers.

Impact of capital gain tax changes on equity markets

The long-term capital gain tax (LTCG) on sale of listed shares has been increased from 10% to 12.5% and the short-term capital gain tax (STCG) has been increased from 15% to 20%. The market reacted negatively to the announcement initially. However, all the losses were recouped within an hour. This has surprised many market participants who believed that any hike in capital gain tax would be detrimental for the markets.

My thoughts on this are as follows:

(a)   Tax is a function of actual profit gained or loss incurred by an investor. Stock price of a stock is a function of the demand and supply of such stock at a given point in time. Demand and supply in turn are determined by the future price expectations. If a larger number of buyers expect the stock price to rise in future, the demand will stay higher, and vice versa. Thus, if the "return expectations" of investors stay high, stock prices may not correct regardless of the cost of transaction and/or taxation of gains. The market correction may need a bigger reset for a meaningful correction. Tax or STT alone would not do much.

(b)   The capital gain tax structure has not only been simplified, on an average, the effective rates of taxation may be actually lower for many investors. For example, tax rates for STCG on listed bonds, Equity FoF, Gold/Silver ETF, have been reduced and holding periods are also aligned with listed shares. Similarly, tax rates for LTCG on Equity FoF, Overseas FoF, Gold/Silver FoF, Gold Funds, physical gold, unlisted stocks and foreign equity have been materially reduced.

(c)   Contrary to first impression, the budget may be positive for the real estate sector. The effective LTCG on sale of properties may be lower, despite lack of indexation benefit, in a majority of cases. Besides, the likely reduction in stamp duty may benefit the buyers.

(d)   By bringing taxation of listed bonds at par with equities, while keeping bond funds taxable at a much higher rate, the government wants to kick start the growth of the retail debt market, especially after inclusion of Indian government bonds in the JP Morgan bond index.

Gold

The finance minister has cut effective import duty on gold from 15% to 6% in this budget. Besides, the capital gains tax on physical gold, gold funds and gold/silver ETFs has been reduced materially.

These proposals have baffled my market participants. They have argued that this may lead to undue rise in import of gold, this adversely affecting the trade balance. Secondly, bringing LTCG taxation of gold at par with equities and bonds is against the spirit of financialization of domestic savings. It is pertinent to note that the NDA government has strived to financialize gold holdings through Sovereign Gold Bonds and other measures in the past 8 years.

In my view, there could be three reasons behind the proposal to cut tax and duties on gold.

(a)   RBI has been the largest importer of gold in India for the past couple of years. It is likely that RBI wants to further enhance its gold holdings, like the central banks of China and Russia, amidst rising global uncertainties over USD supremacy. Lower duties may help RBI to import gold cheaper.

(b)   The first series of SGBs is coming up for redemption next month. The government wants to redeem these bonds at a 9-10% lower price.

(c)   The policy makers have recently raised the issue of “excessive financialization” of the Indian economy. For example, the latest Economic Survey highlighted, “the financial sector should expand at a pace that is in lockstep with economic growth. In particular, India can ill-afford the economy's over-financing at its current development stage.” Cheaper gold prices may be an effort to set the clock back.

STT

The budget proposes to increase the securities transaction tax on sale of an option in securities from 0.0625% to 0.1% of the option premium, and on sale of futures in securities from 0.0125 per cent to 0.02 per cent of the price at which such “futures” are traded. This is an effective hike of 60%.

This is obviously supposed to act as a deterrent to excessive speculation in derivative trades by retail investors. The finance minister, the SEBI Chairperson and other policymakers have categorically expressed their displeasure over the rising retail participation in the derivative trading.

It is pertinent to note that as per a study conducted by NSE/SEBI over 90% retail traders lose money in their derivative trades.

It is interesting to note that the finance minister has assumed a ~16% rise in STT collection in her budget calculations. This implies that the government does not believe any material reduction in trading volumes at stock exchanges.

Besides, the hike in STT may not serve its stated purpose, as the retail traders treat option trades as lottery tickets. A small absolute hike in transaction cost may not deter them from trying their luck. It is the high frequency traders (HFT or Algo driven traders) who will be affected the most. If this affects their volumes, it may actually have detrimental impact on the entire market. For example, some of the HFTs may shift their base to overseas; the liquidity may diminish materially affecting the returns on arbitrage funds and hedging function.

Equity markets

Most people were satisfied with the performance of markets in general and their personal portfolios in particular. Almost everyone believed that the stock prices will continue to rise for the next couple of years at least; though there could be some intermittent corrections. Everyone appeared prepared to invest more money in stocks. The return expectations from equity investments were in high teens on the lower side.

With a few exceptions, most people appeared market cap agnostic in their investment strategy. In fact, the awareness about SME segment stocks surprised me. Both mutual fund and stock folios are well diversified across market cap segments.

Everyone had a story to tell about multi-bagger stocks, especially PSU Banks, Defense, Railways and power sector stocks. Some were proud to own a couple of them since the IPO. Some regretted selling them too early and buying again. Some rued missing this once in a decade opportunity.

Most market participants lamented the losses traders are incurring in the derivative trading. However, none admitted to be trading in derivatives himself/herself.

A significant number of participants claimed a material elevation in their lifestyle due to the gains made from strong market performance. These gains resulted in the form of higher fee/brokerage income and gains. Move to a larger/expensive house and more frequent foreign vacations were too top cited indicators of lifestyle elevation.

Union Budget

None of the participants expected any material change in income-tax rates or rules. It is felt that other than minor tinkering in standard deduction or slab structure, no other change may be made this time. Most expect the fiscal consolidation and focus on infrastructure to continue. No one spoke confidently about “coalition dharma” impacting the budget, but everyone would like to see if it does.

There was enthusiasm about railway and defense allocations. However, most of it appeared to be driven by portfolio positioning rather than any rational explanation.

Corporate performance

The market participants and industry people were most sanguine about the performance of power, telecom, construction and healthcare & pharma sectors. The opinion was divided vertically about the financials, commodities and manufacturing sectors. IT Services and Consumers appear to be carrying least expectations.

Note: This is based on casual discussions with a very small group of people. It may not be close to the real picture. Readers may like to dig deeper and seek views of a larger group. I shall be happy if any reader wants to add or challenge any of these notes.

In my view, the stock market outlook in India, in the short term, is a function of the following seven factors:

(1)        Macroeconomic environment

(2)        Global markets and flows

(3)        Technical positioning

(4)        Corporate earnings and valuations

(5)        Return profile and prospects for alternative assets like gold, real estate, fixed income etc.

(6)        Greed and fear equilibrium

(7)        Perception about the political establishment

The outlook for these seven factors for next 6-9 month is as follows, in my view—

Macroeconomic environment – Positive

My outlook for the likely macroeconomic environment in 2H2024 is as follows:

(a)        Inflation: The consumer inflation may average close to the lower bound of RBI’s tolerance bound of 4% to 6%.

(b)        Fiscal Deficit: The fiscal situation of the central government may remain comfortable as the tax collections remain steady and revenue expenditure is controlled further.

(c)        Rates: Expect benchmark yields to average in the 6.85% +/- 15bps range. The RBI may stay on ‘pause’ for now. Deposit and lending rates may stabilize around current levels, the liquidity may ease in the forthcoming busy season as government spending accelerates.

(d)        Current Account: Expect current account balance to stay negative as import growth continues to outpace exports. The deficit may average around 1.25% to 1.5% for 2H2024.

(e)        Savings: Household savings may continue to grow at a slower pace as real wage growth remains poor. Aggregate corporate savings though may be higher due to continued deleveraging and rise in free cash flows.

(f)         Investment: The government investment expenditure may sustain at current pace. Private capex may see further recovery in 2H2024. Overall, investment growth may see decent growth.

(g)        Exchange Rate: USDINR may average close to INR83.5 +/- 1 range on a stable current account and higher Fx inflows.

(h)        Growth: The real GDP growth for FY25 may average around 7% despite a slower global economy, on the back of better manufacturing and good monsoon. Overall, macroeconomic outlook is positive.

Global markets - Neutral

The global analysts and economists are nearly unanimous on the growth stability in 2H2024. The likely monetary easing and stable geopolitical conditions may support growth stability. The outlook for USD is neutral as central bankers remain on a corrective path.

Technical Positioning – Negative

Technically, in my view, the benchmark indices may witness a decent correction in 3Q2024 before a sustained rise. At present level thus Nifty offers a negative risk reward.

Technically speaking, Nifty may move in the 20210-24995 range in 2H2024, averaging above 22635. There could be occasional violations of this range. Buying below 22700 will therefore carry a positive risk reward.

Corporate earnings and valuations - Neutral

The earnings growth momentum is peaking after three years of strong show. The visibility of margin improvement is clouded as capacity utilizations are high and companies are initiating expansion plans. Raw material prices are also now ticking up.

The present forward valuations are slightly above long-term averages based on still marginally optimistic earnings forecasts. However, 2H2024 may not witness a material PE derating as macro fundamentals remain strong and visibility of flows is improving.

Alternative return profile - Neutral

Real estate: Real estate prices may not rise materially in 2H2024 as more supply hits the market higher interest rates begin to bite and government incentives are withdrawn gradually.

Gold: Presently, there is no major trigger for the global gold prices to rise significantly in 2H2024. Save for a major geopolitical escalation, gold offers a neutral to marginally negative risk reward.

Cryptocurrencies: In the past couple of years, Cryptocurrencies have emerged as a notable alternative asset class. Being a new asset class the level of understanding and awareness about this asset class is still low, though the participation has risen exponentially. This combination of low understanding - high participation makes it highly volatile. Nonetheless, its popularity remains high and this trend may continue in 2H2024 as well.

Fixed income: The corporate bond yields and deposit rates appear to have stabilized and may see some downward bias in 2H2024. The yield gap is now not material. Overall, in my view, the return profile of alternatives is neutral for equities.

Greed and fear index – Negative

Historically, the most successful, though intuitive, indicator of greed overtaking the fear in the market is sharp outperformance of small cap stocks over large cap stocks. Besides, the volatility index, another gauge of fear, has remained low despite several concerns emerging.

The recent sharp outperformance of smallcap stocks and unsustainable euphoria in few pockets of the markets, indicate that greed is dominating the sentiments. The Greed and Fear balance therefore is negative presently.

Perception about the political establishment - Positive

Strong commitment to promote manufacturing in India; positive outcome of thrust on self-reliance and firmly controlled fiscal balance is keeping markets’ perception about the political establishment positive. However, any significant losses for BJP in the assembly elections scheduled in 4Q2024 may require a review of this position.

Outlook for Indian markets

In view of the positioning of the above seven key factors, my outlook for the market in 2H2024 is as follows:

(a)   NIfty 50 may move in a large range of 20210-24995 during 2H2024. It would be reasonable to expect low single digit return for the 2H2024 on diversified portfolios.

(b)   The outlook is positive for IT Services, Pharma, Specialty & Agro Chemicals, Capital goods, organized retail and consumer durables. Commodities and Financials are neutral.

(c)    Benchmark bond yields may average 6.85% +/- 15bps for the year. Long duration yields may do better in 2H2024.

(d)   USDINR may average close to 83.5+/- 1 and move in the INR82.5-84.5/USD range.

(e)    Residential real estate prices may ease in most metro and large cities.

Some key risks to be monitored for the market in 2H2024

1.    Weather conditions especially poor distribution of monsoon rains.

2.    Worsening geopolitical situation in Europe and Asia.

3.    A recession forecast for FY26.

4.    Sharp rise in credit cost for lenders.

5.    Unusual rise in rural stress.

2H2024: Investment Strategy

Asset allocation

2H2024 appears to be marginally worse than 1H2024 as the market technical have worsened. Accordingly, I am changing my primary investment objective to “low returns and capital preservation”. I believe that the market may continue to offer attractive opportunities to build a good portfolio for the period beyond 2024.

I shall continue to maintain standard allocation in 2H2024; and increase active trading in my equity portfolio to optimize return. My target return for the overall financial asset portfolio for 2H2024 would be 8% annualized.

Equity investment strategy

I would maintain a 60:30:10 mix of large, midcap and smallcap stocks.

(a)   Target 18% annualized appreciation from my trading portfolio;

(b)   Overweight on Chemicals (specialty and Agro Chem), IT Services, Pharma, organized retail and niche consumer stocks.

(c)    Underweight on financials and avoid PSUs.