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2023 defied the consensus view of moderate equity returns given the background of rising global interest rates, limited scope for valuation expansion and elevated crude prices amid geo-political tensions. The Sensex delivered a total return of 19.1%, majorly supported by earnings growth. BSE Mid cap and BSE Small cap indices delivered returns of 44.7% and 46.7% respectively. Returns in large and mid-cap indices were majorly driven by earnings growth with flattish earnings multiple. This is indicative of the strengthening of the earnings upcycle which commenced in FY22. (Note: YTD Return figures as of Dec 15, 2023 are considered)

Key Triggers to decide market direction in 2024:

• Demand Pickup in mass segment

Demand in mass market and rural segments remain muted since the pandemic due to inflationary pressures. A moderation in inflation could supporta recovery in the mass market segment, further strengthening the ongoing economic upcycle. While the earnings growth in recent quarters was driven by margin expansion, volume growth driven by  broad-based demand could support earnings growth in 2024. Volume recovery in rural focussed two-wheeler sales indicate green shoots in rural consumption.

• Private Capex Revival

Most of the recent capex was driven by government sector. As per RBI survey, capacity utilisation in manufacturing sector is near a healthy level of 74-75%.Buoyant demand environment along with a pickup in utilisation could strengthen the private capex trajectory.Private capex is showing early signs of revival. As indicated in the below graphs, share of private sector in new project announcements has meaningfully improved.

Private Sector Leads in New Project Announcements:

• Foreign Flows

While DII flows have been robust for the past few years, rising global interest rates have kept FPI flows under check. DIIs have invested $ 20.2 bn in 2023on top of $ 35.8 bn in 2022. FPI flows have been tepid at $ 12.8 bn this year,but better than the outflow of $ 16.5 bn in 2022(Data as of Nov-2023). This has resulted in decadal low FPI ownership in Indian equities. As global inflation and interest rates moderate, India’s stable policy environment and resilient economy could attract meaningful foreign flows.

Segments that could drive Markets in 2024:

Investors need to be selective as most sectors have seen a favourable earnings cycle along with stellar returns. The trajectory of consensus earnings estimates of a sector along with recent return profile can provide insights to identify the next set of market drivers. Two promising sectors which have delivered relatively muted returns along with a potential improvement in earnings trajectory are Banks and IT. Favourable credit cycle coupled with a revival in corporate credit offtake can drive earnings of banks. A likely soft landing in the US can trigger a faster conversion of deal wins to revenue in IT sector.

Apart from fundamental reasons, these two sectors could be major beneficiaries of a reversal in FPI flows.

IT and Banks: Muted Earnings Expectation and reasonable valuation

As indicated in the below graph, small and mid-cap stocks have recorded relatively better returns compared to their earnings growth. Apart from normalisation in earnings, higher flows into these categories have contributed to the superior returns in the segment. Cumulative share of flows into small and mid-cap categories over the past 3 years stands at 28.3% Vs AUM share of 19% (Source: AMFI, Data as of Nov-23). On the back of relatively lower historic returns compared to earnings growth, large caps appear favourable on a risk-reward basis.

Median Return and EPS CAGR across market cap categories

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