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Correction to Opportunity: Large Caps & Quality Remain in Focus

Axis Top pick basket declined by 9% in Feb’25 in a highly volatile month that witnessed rather mixed performance across the sector, market cap and style indices. The start of 2025 has been one of the toughest in recent times on account of the underperformance of the domestic market vis-à-vis other emerging and developed markets. Led by volatility, the broader market adopted a more cautious approach during the month. Mid and Small Caps declined by 11% and 13%, respectively, while Nity-50 declined by 6% MoM. The mixed performance exhibited by sector and style indices points towards some degree of underlying change in the market regime. Nonetheless, our Top Picks basket managed to deliver an impressive return of 265% since its inception in May'20, which stood significantly higher than the 139% return reported by Nifty-50 over the same period.

Challenging start for 2025:

After delivering a strong performance in 2024, the broader Indian equity market witnessed some moderation in January and February. A wider correction was seen in the broader market as compared to large caps in the past two months. With this correction, the market saw a recent bottom of 22125 on 28 th Feb’25, a correction of almost 16% from the top. This was last seen on 27th Sep’24. During the same period, the broader market indices, including the Midcap and Smallcap indices, corrected by 21% and 25%, respectively. A majority of correction was driven by 1) US trade policy Uncertainty, 2) Rise in the US Bond yields and Dollar Index, 3) Slowdown in the domestic earnings growth, 4) FII selling, and 5) A lack of more substantial positive news in the domestic market. Driven by the dominance of these negative factors, Indian markets are now stuck in an oversold zone. Currently, 8% of the NSE 500 universe is trading above the 200-day moving average. Historically, whenever this number falls below 20%, the market tends to find a bottom for that period. Consequently, some breather rally could be expected in coming weeks

Domestic concerns are addressed, and macro development remains watchful:

A series of domestic events are indicating better days in FY26 as compared to FY25. These events are 1) A 50bps CRR cut by the RBI in Dec’24 2) Consumption boost in the Union Budget 3) A 25bps Rate cut by the RBI in Feb’25 MPC, and 4) Improved liquidity measures by the RBI. All these events indicate better days in FY26 in terms of improved credit growth and overall improvement in consumption. However, in the near term, macroeconomic risks like trade policy uncertainty, relatively expensive valuations even after the correction, and absence of a positive trigger (we still have 40 days for Q4FY25 earnings season) will continue to pose challenges to the market direction. In this regard, we believe the Indian market may continue its underperformance relative to emerging and developed markets for some more time.

We also believe that with the recent correction, the market has reached the flattish returns on a one-year scale, indicating that all the gains the market had gathered in the first half have been wiped out in the last five odd months. We expect near-term consolidation in the market, with breadth likely to remain narrow in the immediate term. Hence, the focus remains on style and sector rotation. The Indian market has already seen the price correction in the last five months.

In the absence of any positive trigger, the market is likely to see some time correction for the next couple of months. Nifty is currently trading at 18.1x on 12m fwd earnings, which is slightly below its 5-year average of 18.8x and around at 10- year average of 18.x. Nonetheless, valuations appear attractive for the large caps vs. the broader market, where the margin of safety is still missing. Against this backdrop, we believe that the large cap stocks, ‘quality’ stocks, monopolies, and market leaders in their respective domains may outperform the market in the near term. In any case, the long-term story of the broader market continues to remain attractive and, in this context, we continue to like large cap private banks, Telecom, Consumption, Hospitals, Interest-rate proxies, as well as selective IT and Pharma plays. At the same time, we also foresee earnings growth risk in Capex play and export-oriented themes. We continue to avoid high beta and momentum stocks for the near term.

We maintain our Top Picks recommendations unchanged for the month as we continue to focus on the thematic approach of superior-quality companies.

Our Key Themes

Key Monitorables in 2025: Most significant events are now behind us, with most of the negatives concerning earnings already factored into the price. Hereon, the market will closely monitor the global developments around the following events: 1) Further developments in the US government’s policies, 2) Developments in the reciprocal tax, 3) Further rate cuts by the US FED in 2025, and 4) The direction of currency and oil prices in 2025.

On the domestic front, the market will closely monitor developments around the rate-cut trajectory in India. We anticipate one more rate from the RBI in 2025,

contingent upon inflation trends and broader growth dynamics. These events are expected to keep the Indian equity market volatile, and it could respond in either direction based on these developments. Nonetheless, we continue to believe in the long-term growth story of the Indian equity market. The increased Capex outlay would boost banks' ability to drive credit growth, which we believe is wellsupported by a favourable emerging structure. However, with current valuations offering limited scope for further expansion, growth in corporate earnings will be the primary driver of market returns going forward. Hence, bottom-up stock picking focusing on ‘Growth at a Reasonable Price’ and ‘Quality’ would be key levers to generate satisfactory returns in the next year

Better earnings growth in FY26 vs. FY25:

The Q3FY25 earnings have been broadly in line with expectations, with 70% of the NIFTY 50 companies reporting earnings that either beat the estimates or were in line with them. While earnings expectations were modest, meeting quarterly projections was also challenging for most companies. In this context, given the weakness in Q2FY25, the in-line Q3FY25 numbers provide a welcome relief. We now foresee an FY25 EPS growth rate of 5.3%. Excluding Oil & Gas, the growth for FY25 is 8.5%. Most of the dent in the Nifty earnings were led by cyclical sectors like Oil & Gas and Metals. Overall, FY26 will likely be better than FY25. Like Q3FY25, Q4FY25 earnings will continue to be challenging for the cyclical sectors. More promising numbers are likely to be visible from Q1FY26 onwards, led by base effect (Lower base due to election), the likelihood of improvement in the High-frequency indicators, the expectation of higher government spending, and consumption pick-up.

We are reducing the Dec’25 Nifty target to 24,600

Base case: We believe the Indian economy remains well-positioned for growth, serving as a stable haven amid global economic volatility. We remain confident in India’s long-term growth story, supported by its favorable economic structure, rising Capex, and the consumption boost from the recent Union Budget, which is expected to drive higher credit growth for banks. This is expected to support double-digit earnings growth, ensuring that Indian equities can deliver strong double-digit returns over the next 2-3 years. Against this backdrop, we foresee Nifty earnings to post excellent growth of 14% CAGR over FY23-27. Financials will remain the biggest contributors for FY25/26 earnings. However, the trade policy uncertainty, rupee depreciation, and relatively higher valuations vs. other emerging markets, even after the correction, will continue to pose risks to the market multiple in the near term. Based on these factors, we reduce our base case Dec’25 Nifty target to 24,600 by valuing it at 19x on Dec’26 earnings.

The current level of India's VIX is below its long-term average, indicating that the market is currently in a neutral zone (neither panic nor exuberance). While the medium to long-term outlook for the overall market remains positive, we may see volatility in the short run. Hence, we recommend investors to use the current dips in a phased manner and build a position in high-quality companies (where the earnings visibility is quite high) with an investment horizon of 12-18 months.

Bull Case: In the bull case, we value NIFTY at 21x, translating into a Dec’25 target of 27,000. Our bull case assumption is based on the Goldilocks scenario, which presumes an overall reduction in volatility and the success of a soft landing in the US market. At present, we find ourselves at the start of the rate cut cycle, and the outlook for a soft landing has notably strengthened over the last one to two months. The market is keenly watching the global growth scenario in 2025 under Trump's presidency. Furthermore, the private Capex, which has been sluggish for the last several years, is expected to receive a much-needed push in the upcoming years with an expectation of policy continuity. Backed by expectations of political stability, policy continuity, fiscal prudence path, improving private Capex cycle, rural revival, and soft landing in the US market, Nifty earnings will likely grow at 17-18% over FY23-27. This would augur well for capital inflows into emerging markets (EMs) and increase the market multiples in the domestic market.

Bear Case: In the bear case, we value NIFTY at 17x, translating into a Dec’25 target of 22,000. We assume the market will trade at above-average valuations, led by the likelihood of a policy shift in the Trump regime. Moreover, we presume that inflation will continue to pose challenges in the developed world. Currently, the global market has not seen such levels of interest rates in the past. Hence, the chances of going wrong have increased significantly. Nonetheless, the direction of currency, oil prices, and development towards global trade is likely to put pressure on export-oriented growth in 2025. These developments will likely bring down the market multiple in the near term.

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