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Sharp market correction offers opportunities

* Is the market close to a bottom? Multiple factors suggest that the Indian equities could be in the latter stages of correction unless any extreme unforeseen risk materializes. We believe that the modest earnings growth so far in FY25 should give way to double-digit growth in FY26. Market valuations have eased, especially in large-cap stocks, with Nifty-50 trading at a ~10% discount to LPA. India’s fiscal and monetary policies have turned stimulative, which should support demand and sentiment. Nifty-50 has corrected ~16% since late Sep’24, which is close to the median correction and maximum non-black-swan correction of the past 10 years. FII selling of ~USD28b is 85%+ of the highest selling in the past decade. Moreover, the recent global factors that are instrumental in these corrections are also turning around, with the Dollar Index, S&P500 and US bond yield retracing to levels closer to pre-US election results.

* Buying opportunity emerging in select names: In this report, we identify key beaten-down names that have corrected meaningfully and currently appear out of favor, but for which our analysts have a strong conviction over their earnings growth, business momentum and quality of business model/management – suggesting that the stock correction likely factors in excessive pessimism. Our top picks identified based on the above criteria are as follows: Large-caps: RIL, Bharti, Hindustan Unilever, L&T, Maruti, Titan, Adani Ports, Bharat Electronics, LTIM, Shriram Finance, JSW Energy and Polycab; SMIDs: HDFC AMC, Coforge, Page, AU SFB, JK Cements, Ipca, Godrej Properties, Brigade, Angel One, and Happy Forgings.

* Stimulative fiscal and monetary policies should help revive demand: The Indian policy setting is also becoming more accommodative, which should begin to lift demand impulse over the next few quarters. Both the monetary and fiscal policies have pivoted to spur domestic consumption and liquidity. India’s Finance Minister, in the FY26 Union Budget, flexed the government policy to stimulate consumption through INR1t worth of budgeted savings for taxpayers.

* Multiple monetary measures reflect RBI’s accommodative stance: On the monetary front, the RBI recently embarked on a rate-cut cycle after five years (last rate cut was in Mar’20). In the lead-up to the rate cut, the RBI had also been boosting domestic liquidity through various measures such as: 1) CRR cut from 4.5% to 4.0% (INR1.16t), 2) OMO purchases (INR600b), 3) FX swaps (INR450b), and 4) VRR auctions (INR42.2t). On 5th Mar’24, it announced further measures that will potentially infuse liquidity through fresh OMOs (INR1t) and FX swaps (~INR0.9t). Both fiscal and monetary policies have turned more accommodative, which, in our view, will boost the demand impulse and growth over the coming quarters.

* A perfect storm: Indian markets have corrected meaningfully over the last five months, with the Nifty-50/Nifty MidCap/Nifty SmallCap down ~16%/21%/24% (as of 4th Mar’25) from their peak. The broad-based correction is mainly attributed to modest 9MFY25 earnings growth, continuous FII selling since Oct’24 (~USD28b), a challenging geopolitical backdrop, and a strengthening dollar index that has drawn funds away from various markets. The stock-level correction has been even more pronounced, especially for SMID, as weakening earnings growth and elevated valuations coincided with shrinking risk appetite. Nifty MidCap and Nifty SmallCap peak multiples have fallen to ~27x/20x (from ~35x/24x) but remain elevated.

* Earnings moderated sharply in FY25, improvement likely in FY26: A slowdown in corporate earnings growth has been one of the key factors behind weak market sentiment, as Nifty-50 has managed only 4% YoY PAT growth in 9MFY25 (vs. a healthy 20%+ CAGR during FY20-24). While 4QFY25 will likely be another weak quarter (Nifty PAT growth likely at 4% YoY), we expect 16%/19% YoY growth in Nifty/MOFSL PAT in FY26E. Although there could be some risk to FY26E earnings in the current backdrop, we believe that growth would still be in double digits. Once the extreme risk aversion and weak sentiment abate, the equity market would be guided by a better earnings growth trajectory in FY26.

* Current peak-to-trough correction at past-decade median: Based on our analysis of Nifty-50’s correction phases in the past 10 years, it appears that the Indian equity market could be in the latter stages of correction unless some extreme unanticipated risk materializes. Nifty-50 has already corrected 16% in the current peak-to-trough journey, which has been in line with the median 17% dip in the episodes of 10%+ corrections in the Nifty-50 and maximum peak-totrough dip in non-black-swan episodes over the past decade. Interestingly, the peak Nifty-50 multiple at the start of previous correction phases was higher in several occasions, giving some valuation cushion for large-caps, even as SMIDs trade much above their past 10-year average valuation relative to Nifty. This also corroborates our stance to overweight large caps over SMIDs – our model portfolio has 76% weight on large-caps compared to 16% on mid-caps and 8% on small-caps.

* When will FII outflows abate/reverse? Currently, this is the most topical question we have come across in our recent investor interactions. While it is difficult to point out the inflection point, it does appear to us that a large part of FII outflows should be behind. The current bout of FII selling (of ~USD28b) in the past five months has been an outlier. The selling is ~85% of the highest streak of FII outflows (of USD32.5b) seen between Oct’21 and Jun’22. Lower corporate earnings growth and a slowing domestic economy have been key domestic factors, while strengthening US bond yields, rising USD Index and China’s AI breakthrough have been key external drivers of the current bout of FII outflows.

* FII outflows affecting markets but their marginal impact getting smaller: While Nifty has corrected ~16% in its peak-to-trough journey, the impact of FII flows appears to be more calibrated versus previous episodes. During the 2015-16 phase, FIIs had sold ~USD4b in Indian equities, which led to a 23% market correction. The current bout of FII selling has been ~7x bigger at ~US28b, while the market has corrected ~16%. Even adjusting for Index levels, the intensity of the current bout of FII selling has been ~2.7x of the 2015-16 phase, though market correction has been lower. This reflects a milder impact of FII selling on the Indian market and the increased counterweight of DII inflows, which remained strong at ~USD44b during the current phase of market weakness.

* India could eventually be a net beneficiary of global realignment: Any eventual strength in the US economy on back of multi-faceted policy measures, should likely be beneficial for Indian exporters, while US’ reciprocal tariff policy may not cast a severe dent, in our opinion. The finance minister had proactively lowered customs duties on some import items in the Union Budget, and the Prime Minister in his recent US trip has indicated a stronger partnership with the US on the energy and defense fronts, which will help to narrow the deficit and assuage US concerns. In addition, the US-China trade standoff should help redirect some global demand requirements toward other countries, including India. Hence, once the dust settles on the initial reaction to the new US administration announcements, we believe FII outflows from Indian equities should start to moderate.

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