Take a deep breath, hold and let it go

The market action in the past three days has been quite exciting. It reminded me of the market action witnessed during March-April 2020, in the wake of the outbreak of Covid-19 pandemic. Drawing from the experience of 2020, like many, at first, I was also tempted to increase my risk exposure to Indian equities. However, on second thought, I have decided to reign my temptation and avoid any deviation from the “plan”.

I note that the 2025-2026 market trajectory may not be similar to 2020-2021, for some very simple reasons.

·         Ignoring the panic fall in February-March 2020 and subsequent recovery, Nifty 50 gained 12% in 2020 and another 16% in 2021. These gains occurred because corporate earnings were coming out of a 10yr growth drought. Nifty EPS has grown over 225% in the past five years (FY21-FY25), against just 50% growth witnessed in the preceding decade (FY11-FY20). The growth trajectory is now moderating and is more likely to stabilize in 11-13% CAGR range in the next couple of years.

·         Presently, Nifty 50 forward consensus PE is marginally higher than the long term (10yr) average. With earnings growth moderating, there is no reason for the PE to re-rate to the higher levels. If at all, it can slightly de-rate to the long-term average. This implies that Nifty 50 returns are most likely to be in tandem with the earnings growth (11-13%), in the next couple of years, with some downside risk.

·         2024 has witnessed a record Rs5.26 trillion domestic flows into the local secondary market alone. Accounting for flows into primary markets, unlisted securities and foreign equities, domestic flows would be much higher. Expecting this kind of flow to sustain during 2025-2026 also, would be unreasonable. Given the currency weakness, higher cost of capital (bond yields) and rising uncertainties, foreign flows may not see a significant reversal from the 2024 trend, where foreign investors were marginal sellers (adjusted for buying in primary market).

·         The economic growth in 1HFY25 has been much below the expectations. No major recovery is expected in 2HFY25 and 1HFY26. The actual government capex for FY25 is expected to be much lower than the budget estimates. There are reports which suggest that the capex budget for FY26BE may not see any material growth. This trend raises reasonable doubts over the sustainability of the higher than historical valuations of the sectors and companies that were expected to benefit from higher government capex. For example, infra builders, PSEs, railway equipment suppliers, etc.

·         Financial sector, especially public sector banks, have contributed materially to the market buoyancy in the past four years. The rally in these banks was led by recapitalization, NPA resolution/recovery (asset quality improvement), margin expansion and high credit growth. None of these factors may be contributing in the next two years. Asset quality and margins have mostly peaked, and credit growth is moderating.

·         Last but not the last, one of the keenly watched indicators - the Market cap to GDP ratio – is at an all time high. With nominal growth trajectory settling at single digit level, and IPO activity remaining strong, the risk of market cap of the existing listed stocks correcting cannot be ignored.

Myth of Tax terrorism

As I mentioned in the preceding post, a narrative of “tax terrorism” is being built strongly on social media, against the incumbent regime. Many popular influencers are repeatedly alleging that the government is squeezing the middle classes too hard through “exorbitant” direct and indirect taxes. Numerous experts have opined that the high taxes are the primary reason for the decline in growth trajectory, especially the private consumption. The followers of these experts are quick to lament that poor infrastructure and civic amenities are totally incongruent with the current structures of direct and indirect taxation.

There is absolutely no denying that regardless of the official claims, the civic infrastructure in most parts of the country remains of poor quality and inadequate. The civic authorities are mostly inefficient, and wastage of resources rampant. Nonetheless, accusing the current regime of coercive taxation policies may not be appropriate, in my view. The taxation structure has witnessed gradual changes in the past four decades. The process has continued notwithstanding the nature of the governing political establishment.

In the past four decades we have seen governments with overwhelming majority in the parliament (Rajiv Gandhi 1985 and Narendra Modi 2019), fragmented minority (V. P. Singh, H. D. Deve Goda, I. K. Gujral) and fragile coalition (A. B. Vajpayee, Manmohan Singh). Many of these governments had communists and socialists as key constituents. The taxation structure has however continued to evolve, mostly in line with the recommendations made in 1993 by the Raja Chelliah Committee. There have been only a few ad hoc measures, like exemption of long-term capital gains on some listed securities (2004) and dividend (1997) from payment of tax, to stimulate higher growth.

Marginal rise in tax revenue during 2014-2024

Past decade has seen only a marginal rise in the overall tax revenue for the central government. Most of this rise in tax collection could be attributed to the implementation of a nationwide Goods and Services Tax (GST) which has resulted in wider coverage of taxpayers and better compliance. Improvement in digital infrastructure of tax departments has also resulted in better surveillance and compliance.

·         In the past decade (FY14-FY24), nominal GDP of India has grown at 10.1% CAGR. In this period, total tax revenue of the central government has grown at 11.5% CAGR.

·         However, most of this tax buoyancy occurred in FY17-FY19 (GST implementation period). During the past five years (FY20-FY24), nominal GDP has grown at 9.3% CAGR, while the tax revenue of the central government has grown at a lower 8.9% CAGR.

·        During FY15-FY24, average income tax per individual tax payer (including HUF assessees) has grown at 7.8% CAGR, much less than the rise in per capita income of 11% CAGR.

No material changes in the taxation matrices during FY20-FY24

Total tax revenue of the central government witnessed a jump (from 10.3% of GDP to 11.9%) during FY15-FY19 period. Most of this jump could be attributed to the implementation of GST, which led to transfer of some part of State levies by the central government.

·         During FY15-FY19 period, indirect taxes collected by the central government grew from 4.7% of GDP to 5.6%. However, in the subsequent five years (FY20-FY24) these indirect taxes have declined to 5.2% of GDP, signifying efficiencies due to single nation-wide tax.

·         Much talked about Securities Transaction Tax (STT) has grown from 0.47% of total tax revenue to 0.93% during FY14 to FY24. This has added to the cost of transaction; though much of this rise may have been mitigated by the fall in brokerage charges.

During the decade of FY15-FY24, total direct taxpayers increased from 5.26 crores to 10.41 crores. A significant part of this rise in the number of taxpayers could also be attributed to GST, which brought lots of smaller (unorganized and/or non-corporate) businesses into the tax net. Material improvement in the digital infrastructure and surveillance system of the tax department in the past decade have also led to better compliance.

·         Direct tax collections grew from 5.6% of GDP in FY14 to 6.3% of GDP in FY19. However, since FY19, it has grown only marginally to 6.5% of GDP in FY24.

·        Personal income tax collection has risen from 37.4% in FY14 to 51.8% in FY24. A large part of this collection could be attributed to non-corporate business income, which is taxed as personal income in the hands of proprietors of the small businesses. Many of these individuals have come into the tax net, post implementation of GST. 

No free food at taxpayers’ expense

The popular narrative is that the government is spending taxpayers’ money to provide free food to 800 million people to lure them to vote for it. This may not be true. The subsidy bill of the central government has been reduced from 14% of GDP in FY14 to just 2% of GDP in FY24.

The food security subsidy in India has actually reduced from 1.1% of GDP (Rs1250bn) in FY14 to 0.7% of GDP (Rs2123bn) in FY24.

I am not writing this to support or oppose any government or political party. I just want to put the record straight and avoid getting carried by the narrative being built on social media.

Also read

Myth of tax-free agriculture income

Game of narratives

Addressing the Student’s Union of London School of Economics and Political Science in 1923, Bertrand Russell said, “One of the peculiarities of the English-speaking world is its immense interest and belief in political parties. A very large percentage of English-speaking people really believe that the ills from which they suffer would be cured if a certain political party were in power. That is a reason for the swing of the pendulum. A man votes for one party and remains miserable; he concludes that it is the other party that was to bring the millennium. By the time he is disenchanted with all parties, he is an old man on the verge of death; his sons retain the belief of his youth, and the see-saw goes on.”

After more than 100 years, his words not only remain true, but also equally applicable to the democracies which are not English speaking; Indian subcontinent being a classical case in point. In the past 75 years, the citizens of India, Pakistan, Bangladesh, Sri Lanka, and Nepal have swung the pendulum several times in the hope of ushering the millennium; but success continues to elude them.

Ten days ago, Dr. Manmohan Singh, inarguably one of the finest politicians India ever had, took his last breath. His demise triggered a debate over his achievements as the prime minister of India. Since, Mr. Narendra Modi was chosen to succeed him, it was natural to draw a comparison between the 10-year governance of Dr. Singh and 10-year governance of Mr. Modi.

More notably, some of prominent people who had been critical of Dr. Singh’s performance, publicly admitted that they were unduly harsh on Dr. Singh by accusing him of causing “policy paralysis”. They are now recognizing that Dr. Singh’s tenure indeed witnessed highest economic growth (7.8% CAGR over FY05-FY14) and several transformative and innovative policy decisions. For example—

·         Constitutional right based social welfare programs (Right to National Identity (Aadhar), Right to Employment (MNERGA), Right to Education (RTE), Right to Information (RTI), Right to Food (NFSA), Right to Healthcare (NRHM) etc.).

·         Significant changes in the foreign policy paradigm, enabling India to form strategic partnerships with several developed countries including Japan, France, the US, Germany and Australia. Signing of the Civil Nuclear Deal with the US marked the most important milestone in the Indo-US relationship.

·         Establishing a strong framework for financial inclusion. Required the RBI to ensure a banking channel in all habitations with 2000 or more people.

·         Establishing a best-in-class core for digitization of the economy through UIDAI and NPCI.

·         Further opening of the economy by permitting/enhancing FDI in retail trade, pension, insurance etc.

The tenure of Mr. Modi has been more about implementing and strengthening some of these policy initiatives; rather than taking new policy initiatives.

Incidentally, like “policy paralysis” in 2013-2014, influencers are now trying to swing the pendulum through building a “tax terrorism” narrative. Fortunately, like “policy paralysis” this narrative is also ill-founded. More on this tomorrow.

Two roads diverging in the yellow wood…

The 2025^th year of the Christ is beginning on a very tentative note, particularly for investors in financial markets. The past four years have been relatively smooth for investors. With the benefit of hindsight, we can confidently claim that the markets were mostly driven by macro factors. Unprecedented liquidity infusion by the central banks and fiscal support to consumers across the world helped most asset classes to perform well.

Despite massive global disruptions due to the pandemic and geopolitical, the volatility in markets was largely contained. Since most asset classes yielded decent returns for investors, they were not really pushed hard to make choices.

However, the trend seen in the past few months is indicating that the conditions might change materially in the next 12-24 months. The macro trends may become ambivalent and unpredictable. Investors may need to make choices; and the return they would earn on their investment portfolios would largely depend on the choices they would make.

Choose your path carefully

Making right choices, in my view, would be the central investment challenge for the year 2025. The following situations, for example, would challenge investors to make a choice.

Promise vs. delivery

In the past few years, the Indian markets have been largely driven by the political and corporate promises, ignoring the actual delivery, especially in the matters of investments, infrastructure development, growth, and profitability. In the past few months corporate promises have started to moderate, albeit very gradually; but the government promises continue to remain rather exaggerated.

The themes like manufacturing for import substitution/export promotion, defense production, railways modernization and expansion, development of tourism ecosystem, clean energy, etc., which were mostly based on the government promise, have been popular with the investors in the recent years. The stocks associated with these themes have yielded extraordinary returns for investors.

Many businesses, especially those associated with these macro themes, also promised sustainable growth and profitability. So far, only a few have delivered on their promise. Very soon, investors would need to choose whether to continue relying on promises or shift the focus on businesses that have been delivering consistently.

Globally, the promises of the Trump 2.0 regime are becoming a major investment theme. The investors would also need to make an assessment of how much of Trump’s promises are deliverable and invest accordingly.

Short stories vs. epics

For ages, collections of short stories like Panchatantra, Jataka Tales, Aesop’s Fables, etc. have been key influencers of the value system, morality and consciousness of human beings. Very few of us would have bothered to read the full text of epics like Ramayana, Mahabharata. We know the broader plots and teachings of these epics through brief narrations by elders, TV shows and movies.

Similarly, most of the successful investors would have created their wealth by investing in some small ‘stories’. Investing in a broader macro trend (epics) requires a lot of patience, deep understanding of economics and deep pockets to weather through the macro cycles. For the impatient, small investors with low understanding of economic cycles, macro trends intermittently provide a lot of excitement. Extraordinary profits made riding popular waves, if not encashed in time and preserved, often perish in no time.

Anecdotal evidence suggests that a lot of investors are presently invested in “the epic India story”. It is important to note that this story has been unfolding since the early 1990s, and might take many more decades to fully unfold. In the past 34 years there have been many periods of rejection of this story as a valid investment theme. 2025-2026 could be another phase when a large section of investors, especially foreign investors, reject this story as bogus.

Small investors thus need to make a choice whether to stay invested in ‘the epic India story’ (macro themes like infra development, demographic dividend, rise in income & consumption etc.) or focus on finding some small stories that may yield results in the short period of time.

"MAGA" and "BRICS as a unified market with common currency" are some examples of global epics, which investors might need to accept or reject.

Jingoistic defiance vs. pragmatic escape

The year 2025 might bring many investors face to face with ground realities – social, political, and economic. Many of them may discover that their current portfolios of investment are not actually in sync with the current ground realities. Investors would need to make a choice whether to stay committed to their current asset allocation and investment portfolios; or make a strategic change and bring the portfolios in sync with the latest ground reality.

This may, for example, require rationalization of tactical debt allocations made to take advantage of sharp fall in bond yields; evaluation of gold allocation made in anticipation of easing bond yields & rising geopolitical tensions; and investment in traditional FMCG businesses which are facing margin & growth challenges.

Absolute vs relative return

With a material rise in the investments made through professional investment managers (MF, PMS, AIF etc.) in the past four years, investors have become used to assessing the performance of their investment portfolios relative to the benchmarks set by these professional investment managers. The relative return argument (or “strategy” if you prefer to use this jargon), functions well only if the benchmark continues to provide positive returns consistently. For those investors who are depending on their portfolio of financial investments to meet key goals of their life, e.g., financial freedom and retirement planning etc., a couple of years of negative return could spoil the entire math.

The investors whose investment objective involves any one or more of the following ought to prefer an absolute return strategy, instead of a relative return argument. For their investment objective would invariably involve a defined cash flow over a definite period of time. Their investment strategy must therefore focus on making a reasonable rate of absolute return over the “defined” period of time. Beating the benchmark index should be the least of their concerns.

·         Retirement planning – regular income to supplement the loss of salary/wages.

·         Goal based investment, e.g., buying a house, children education expense.

·         Financial freedom - assured minimum income to allow

2025-2026 could be one such period where non-institutional investors might have to make a choice between relative return and absolute return strategy.

Universal Basic Income (UBI) taking shape, election by election

Telangana was the first State in India to implement a basic income scheme for all the 6 million farmers of the state, in 2018. Under the Rythu Bandhu Scheme, the state government offers to pay Rs10000/year to the farmers of the state, irrespective of the size of landholding. The amount is given by a bearer cheque through Village Panchayat. Commendably, before implementing the scheme, the State made all land titled good, by completely digitizing the land records and issuing new fully secured title deeds (Land Pass Books) to all the farmers. All land holdings records are transparent and could be digitally verified by anyone.

Subsequently, the state governments of West Bengal and Odisha, implemented their versions of the Telangana scheme. But these schemes lacked the basic ecosystem of clean land records like Telangana, hence were seen prone to leakage and misuse.

Sensing the evolving trend at the state level, the Union Government, implemented a nationwide scheme of guaranteed basic income for small and marginal farmers in the interim budget for FY20. The finance minister announced the “Pradhan Mantri Kisan Samman Nidhi (PM-KISAN)” scheme whereby an annual grant of Rs6000 was promised to the farmers owning less than 2 hectares of land in the country. The grant is paid in 3 installments of Rs2000 each, through a direct transfer to bank accounts of the eligible farmers. However, a large number of landless farmers and the farmers with unclear or disputed land titles are unable to get the benefit of the PM-KISAN scheme.

In the same budget, the finance minister also announced the Pradhan Mantri Shram Yogi Maandhan (PM-SYM) scheme for the urban poor. The scheme envisages a pension of Rs3000 for urban workers on attaining the age of 60yrs. To be eligible, the worker must have registered under the scheme when he/she was between the age of 18-40yr, working in an unorganized sector and earning not more than Rs15000/month.

These schemes are in addition to the older schemes like MNREGA, Old Age Pension Scheme, & various Subsidized insurance Schemes for poor.

Subsequently, many state governments have announced direct cash payment of Rs1000-2000/month to all adult women in the respective states. The trend suggests that it is almost certain that most of the state governments will have this scheme implemented by the time next elections are held in their respective states. It is a matter of time that the central government announces a uniform monthly cash payment for all women citizens.

In my view, the small steps taken towards implementing a Universal Basic Income and wider social security mechanism are transformative. Given the context of elections, presently these might appear hasty and politically motivated. Nonetheless, these proposals shall eventually prove to be watershed in the fiscal policy and social welfare paradigm of the country.

I believe that in next one decade almost all social security and welfare schemes like MNREGA, Old Age Pension Scheme, cash payout to farmer, workers, students and female, & various Subsidized insurance Schemes etc. shall be subsumed in a uniform Universal Basic Scheme (UBI) that may guarantee a basic cash income and health insurance to all citizens. I am not worried about the immediate fiscal impact of these schemes. However, I would like the government to work on developing a robust technology support system for efficient and full-proof UBI in the future.

Greed consistently dominated fear in 2024, or did it?

The sentiments of greed (risk-taking) and fear (risk-aversion) are two key factors that determine the breadth and depth of the stock market performance over a short term.

In the risk-averse phase usually themes like large cap, defensive, value, dividend yield, etc. lead the market performance. In this scenario, the market breadth is usually narrow; fewer companies raise fresh capital; volatility is low; and market breadth is consistently poor.

On the other hand, in the risk-taking phase, themes like small and midcap, growth, cyclicals, etc. lead the market performance. In an environment supporting risk-taking, usually the market breadth is strong, volumes are above average, and volatility is higher. The primary market is very active in this phase, as a larger number of entrepreneurs look to raise fresh capital for growth and deleveraging.

The year 2024, however, has seen some divergent trends. Several contradictions prevailed, which not only raise doubts about the validity of the current risk-taking phase in the conventional sense, but also present a higher probability of emergence of a severe risk-aversion phase in the near term. For example, consider the following:

·        Small and midcap stocks consistently outperformed the benchmark Nifty throughout the year, despite several risk affecting events like BJP not securing majority in the general elections in India; serious escalation in the Middle East Asia geopolitics; outcome of presidential elections in the US threatening a full-scale tariff war; growth slowing materially in Europe, China and India; sticky inflation restricting global easing cycle; corporate earnings failing to meet expectations etc.

·         The promoters raised over Rs three trillion through initial public offerings (IPO), qualified institutional placements (QIP), and rights issues. However, most of the QIP and rights issue money was used to deleverage the balance sheets rather than expanding capacities – usually a sign of risk-aversion. Even many of the IPOs were 'offer for sale', where the promoters diluted their stakes.

·         Foreign portfolio investors have been net sellers in Indian equities in the year 2024. In the secondary market, FPIs sold over INR 1.1 trillion worth of equities in 2024. However, they bought almost a similar amount in the primary market. The share of the Indian listed market capitalization owned by FPIs fell to ~16%, the lowest level in a decade. The domestic institutional investors however purchased over INR 5.1 trillion worth of equities in the secondary market. The share of the market capitalization owned by the household investors increased to the highest level in the past 15 years.

Historically, the correlation of FPIs’ net flows and Nifty returns in a given year has been poor; but the rise of household share in stock ownership has mostly led to a risk-aversion phase in the markets.

·         Despite significant outperformance of the small and midcap stocks, the market breadth and overall traded quantity has not been supportive of a risk-taking trend. In the 6 out of first 11 months of 2024, market breadth has been negative. Overall, the market breadth is neutral. The traded quantity has been mostly below average in the last six months.

·        The implied volatility has been mostly moderate to low, except for a brief spike in May 2024 (election month), usually not a sign of a risk-taking phase.

 

Cautious FOMC spoils the Santa party

The Federal Open Market Committee (FOMC) of the US federal Reserve (Fed) obliged the market consensus by cutting its overnight borrowing rate by 25bps to a target range of 4.25%-4.5%. One member of FOMC voted against the cut, preferring to maintain the status quo.

Noting the economic conditions, especially still elevated inflationary expectations and resilient growth, the Fed indicated that 2025 may see fewer cuts than the previously estimated number. “With today’s action, we have lowered our policy rate by a full percentage point from its peak, and our policy stance is now significantly less restrictive,” Chair Jerome Powell said at his post-meeting news conference. “We can therefore be more cautious as we consider further adjustments to our policy rate.”

The FOMC raised its projection for full-year 2024 GDP growth to 2.5%, from 2% in September. However, in the following years, the FOMC officials expect GDP to slow down to its long-term projection of 1.8%. The committee lowered its expected unemployment rate in 2024 to 4.2%, while headline and core inflation were pushed higher to 2.4% and 2.8% respectively, slightly higher than the September estimate and above the Fed’s 2% goal.

The resilient growth and elevated inflationary expectations would require the Fed to hike or hold rates in 2025. However, officials appear wary of keeping rates too high and risking an unnecessary slowdown in the economy.

Insofar as the Trump 2.0 policies and their impact on the growth are concerned, the Fed Chairman Jerome Powell prefers a wait and watch approach. IN the post FOMC meet press interaction he said, “We’re just not at that stage.” He further added, “We need to take our time, not rush and make a very careful assessment, but only when we’ve actually seen what the policies are and how they’ve been implemented.”

The financial markets reacted negatively to the FOMC decision. Dow Jones lost 1123 (2.58%). Falling for the tenth consecutive day, it has recorded its worst losing streak since an 11-day slide in 1974. The S&P500 (-2.95%) and Nasdaq Composite (-3.56%) fell even more. The benchmark 10-year treasury yields jumped 3.08% to 4.52%, the highest level since April 2024 and 90bps higher than their August 2024 lows. UST Index rose 1.2% to its highest level in almost three years. Gold prices fell 2.3%, taking the yellow metal below US$2600 level after 3 months.

Alternatives continue to remain attractive

Traditionally, the asset allocators have considered the potential return of the various alternatives (to equity and fixed income) to determine the portfolio structure of investors. Of course, the factors like size of portfolio, feasibility of investing in assets like real estate, risk appetite of individual investor, and liquidity requirements etc., influence the allocation to some alternatives. However, dematerialization of assets like real estate (through REITS), Gold (ETF) Bonds (bond funds, RBI direct investment platform etc.) now makes the alternatives relevant even for small investors.

In the past one year, the alternatives assets (e.g., gold, bitcoin) have performed significantly better than equities. Even the average yield of long duration bond funds has been similar to the Nifty50 return. The investors may therefore want to evaluate the return prospects of these alternatives in future to determine their asset allocation strategy.

 

In this context, I note the following to review my asset allocation strategy for 2025.

Bonds

Bond yields have consistently outperformed the equity yields in the past three years. In 2024, even the return on long duration bonds matched the Nifty50 returns. The consensus currently is that the RBI rate cut cycle in 2025 would be shallow with 25-50bps overall cut. Doubts are emerging on continuation of the Fed rate cut cycle also. The resilience of stock prices despite earnings downgrades, implies low chances of any material rise in equity yields. Bonds might thus remain an attractive asset class in 2025 also.

Gold

The World Gold Council (WCG) has forecasted a “positive but much more modest growth for gold in 2025”. The yearly outlook paper of WCG notes that “Upside (in gold prices) could come from stronger than expected central bank demand, or from a rapid deterioration of financial conditions leading to flight-to-quality flows. Conversely, a reversal in monetary policy, leading to higher interest rates, would likely bring challenges.”

The best case for Gold appears reversal in rate cycle with forecast of “higher for longer”. A dovish Fed, de-escalation of conflicts in the middle east and Europe, and lower intensity of trade wars, as compared to the present estimates, could be very negative for gold prices.

The weakness in USDINR, capital controls to manage balance of payment and change in duty structure are some additional factors to be considered for the Indian investors buying gold in INR. To me Gold appears less attractive in 2025.

Real Estate

The demand for housing remains robust, driven by resilient end-user interest and favorable macroeconomic factors. Inventory levels are now low in the ready to move category in most key markets. With new launches in mid segment slowing in the key markets, the prices are expected to remain firm in 2025.

As per Kotak Securities, Commercial real estate in top Indian cities saw healthy traction in 2QFY25. Vacancy levels inched lower. GCCs continue to lead the demand for commercial real estate, even as IT companies increased their headcount in 2QFY25 after six quarters of reduction; utilization rates remain high. Occupancy levels across asset owners have improved, aided by floor-wise denotification and consequent leasing of SEZ areas and a stronger push towards “return-to-office” by IT employers. Despite the recent price uptick, office REITs offer an attractive yield + appreciation play within Indian real estate. For me Real Estate (REITS) will thus continue to remain a preferred asset in 2025.

Crypto

More and more governments are now inclined to view crypto as a legitimate asset. President-Elect Trump has also hinted towards a favorable regulatory regime for crypto assets. As per the global investment major Fidelity, “Liquidity metrics have turned back to positive year-over-year growth, and we have entered another interest rate-cutting cycle. Inflation is still elevated above the Federal Reserve's 2% target and so I personally think there is still a risk of inflation coming back in a 'second wave.' Both of these things would be tailwinds for bitcoin.”

Despite a sharp up move in bitcoins, and high volatility it is difficult to ignore this emerging asset class in overall portfolio allocation.

Bruised or damaged?

A veteran investor recently recommended investors to buy “bruised blue chips”. He was purportedly referring to the consumer goods manufacturers that have underperformed in the year 2024. For reference, Nifty FMCG index is down 0.3% YTD2024 against ~14% rise in Nifty50. Historically in India, the FMCG sector had mostly outperformed the benchmark indices. Intermittent short periods of underperformance were traditionally seen by the long-term investors as an opportunity to buy/add FMCG stocks to their portfolio.

However, the trend seen in the past one decade (reasonably long period in my view) seems to be defying this conventional wisdom. Since 2014, Nifty FMCG has yielded a return of ~236% against a rise of 305% in Nifty 50. Thus, the conventional wisdom of preferring consumer goods manufacturers may not have been a great investment strategy, even accounting for the higher dividend yield in consumer stocks.

In my view, the underperformance of traditional FMCG blue chips is structural and may continue in future also. There are several factors which support this view of mine. For example—

·         I believe that in the Indian consumer market, the balance of power has shifted from the large pan India producers/brand owners (mostly colonial era legacy monopolies) to technology partners (e.g., Quick Commerce, Ecommerce), logistic partners (Modern Retail, Warehousing, Transportation, Payments), regional producers/brand owners (especially for ready to eat food and snacks catering to local tastes and dairy), financiers (consumer finance), scaled up ancillary units catering to multiple brands (contract manufacturing, packaging, digital marketing etc.). The scalability, growth prospects and profitability are much higher in most of these new/emerging “consumer” businesses.

·         The composition of the spending on FMCG basket has seen a conspicuous shift in the past one decade. The current FMCG basket includes a large portion of consumer services, e.g., Data, Food Delivery Services, Beauty and Personal Care Services, Healthcare (Diagnostics, Insurance, Clinic), Air Travel, Quick Service Restaurant (QSR), etc. The share of goods, earlier considered discretionary, like Alcohol, Transportation and Cooking Fuel, Packaged Ready to Eat Food, Fashion Accessories, etc. has also increased materially in the middle-income households’ non-discretionary consumption basket.

·        It is estimated that the share of the items traditionally considered “discretionary” in the India consumption basket may increase 3x from 13% in 2000 to 39% in 2030. The stock market is obviously interested in growth (discretionary consumption), moving away from de-growth (staples).

·         In a few years, some of the food delivery services providers, quick commerce platforms, QSR chains, beverage bottlers, traditional sweets & snacks brands may become bigger, more popular and fit the “Buffet Investment Criteria” better than the traditional FMCG brand owners/producers.

I shall therefore not be in a hurry to buy the 2024 underperformers; for some of these might be damaged, not just bruised.

Also read:

Trends in household consumption

Living on hope

The Reserve Bank of India (RBI) recently released the results of its latest forward-looking surveys (November 2024 Round). Based on the feedback received from the respondents the survey results provide important insights with respect to consumer confidence, inflationary expectations and economic growth expectations.

Consumer confidence – Present tense, hopes high for future

The survey collects current perceptions (vis-à-vis a year ago) and one year ahead expectations of households on general economic situation, employment scenario, overall price situation, own income and spending across 19 major cities.

As per the survey results, Consumer confidence for the current period declined marginally owing to weaker sentiments across the survey parameters except household spending. The current situation index (CSI) moderated to 94 in November 2024 from 94.7 two months ago. (A value below 100 indicates a state of pessimism)

However, for the year ahead, consumer confidence remained elevated, improving 50bps from the previous round of Surveys. Households displayed somewhat higher optimism on one year ahead outlook for major economic parameters, except prices. The future expectations index (FEI) stood at 121.9 in November 2024 (121.4 in the previous survey round).

The respondents’ sentiments towards current earning moderated marginally, they displayed high optimism on future income which was consistent with their surmise on employment conditions. Households anticipated higher spending over one year horizon on the back of higher essential as well as non-essential spending.

Household inflationary expectations rise

Households’ perception of current inflation rose by 30bps to 8.4%t, as compared to the previous survey round. Inflation expectation for three months horizon moderated marginally by 10 bps to 9.1 per cent, whereas it inched up by 10 bps to 10.1 per cent for one year ahead period.

Compared to the September 2024 round of the survey, a somewhat larger share of respondents expects the year ahead price and inflation to increase, mainly due to higher pressures from food items and housing related expenses. One year ahead, the price expectation of households is closely aligned with food prices and housing related expenses.

Male respondents expected relatively higher inflation in one to three months, as well as one year ahead, as compared to the female respondents.

Forecast on macroeconomic indicators – growth scaled down marginally

GDP: Real gross domestic product (GDP) is expected to grow by 6.8% in 2024-25 and 6.6% in 2025-26. Forecasters have assigned the highest probability to real GDP growth in the range 6.5-6.9% for both the years 2024-25 and 2025-26.

Annual growth in real private final consumption expenditure (PFCE) and real gross fixed capital formation (GFCF) for 2024-25 are expected at 6.2% and 7.9% (revised down), respectively. Real gross value added (GVA) growth projection has been revised down marginally to 6.7% for 2024-25 and kept unchanged at 6.4 per cent for 2025-26.

 Inflation: Annual headline inflation, based on consumer price index (CPI), is expected to be higher at 4.8% for FY25 and 4.3% for FY26.

External sector: Merchandise exports and imports are projected to grow at a slower rate of 2.4% and 4.6% respectively in FY25 and recover to 5.5% and 6% respectively in FY26, in US dollar terms. Current account deficit (CAD) is expected at 1.0% (of nominal GDP) during both FY25 and FY26.