Indian markets rallied during the month with gains across market capitalization and almost all major sectors except IT. The catalyst could be the RBI's surprising decision to pause at the April meeting amidst a gloomy outlook that prevailed in March. India has traditionally been a capital-scarce economy where the cost and availability of money matter to growth. The traditional economic theory of monetary easing (lower rates &/or higher liquidity) supports economic activities. In comparison, monetary tightening (higher rates &/or lower liquidity) impacts economic activities in a capital-scarce economy (emerging economies).

In a developed market economy (capital surplus), however, monetary easing or tightening has a far lesser influence on the economy but significantly higher influence on asset markets (higher valuations). We have been witnessing this as the monetary easing of the past decade by the FED and other central banks has created an expansion in valuations across asset classes (Equity, Debt, Real Estate, Bitcoin etc.).

Globally, markets remained volatile with some upward bias as news about ALM-led failures at large regional banks in the USA continued. Fortunately, the issue with banks is far more on interest rate risks rather than credit risks, for now. The outcome of the US Fed meeting on May 3rd is keenly awaited as a pause or a continuation of the rate hike path is relevant for asset market valuations. The money supply infused by Fed post the bank failures suggests that we are more likely to be headed towards an era where money will be available but at a higher cost (interest rates). Suppose this "adequate liquidity available at a higher rate" scenario plays out in the near term or gets priced in. In that case, markets may get into another round of volatility as the leadership can change among stocks. Fed policy action also matters for India as RBI may consider appropriate action at the June meeting.

From the Indian economy and corporate earnings front, the CAPEX cycle across Infrastructure (government, state governments) and Capital goods (Corporates, driven by PLI n China+1) continues. The corporate capex is led by listed and unlisted corporations (FDI and Indian firms). The most notable name has been Apple as it announced India plans during a visit by CEO Tim Cook. Corporate earnings-wise, FY23 has seen a disproportionate share of earnings growth by Lenders (mainly Banks) as they took advantage of higher rates on older assets getting repriced. Higher rates have hurt borrowers (consumers and corporates) across, leading to some slowdown in discretionary spending. FY24 is likely to see Banks sharing higher rates with depositors, which may restore the spending power to some consumers & corporates who have been net depositors. Economic indicators like PMI, GST collections for Apr-23 at an all-time high of Rs 1.87 lac Crs, and real estate sales all show economy is chugging along at a decent pace despite the global recession concerns.

While Fed policy connects remain relevant for markets in the short term, the economic growth and fundamentals remain relevant in the medium and long term. The fundamental story for India remains the rapid growth potential that moves the Indian economy towards the third largest economy status. The core hypothesis for this decade remains India's story of economic growth with the key building blocks:

• public sector infrastructure creation.
• private sector's industrial capex.
• compliance-led tax collection efficiency.
• PLI initiatives led job creation.
• China+1 strategy to get export market share.

India markets have undergone a sea change regarding investor participation in the past 5-6 years. There is an alarming increase in the willingness of investors to become traders by opting to use derivatives. Within derivatives, too, options have become the very dominant way of trading, creating extreme volatilities and quick sector rotations. It is not easy to set a timeline for this trading behaviour to ebb, but that is needed for investors to return to markets with a potential wealth creation objective over 3-5-7 years. On the other hand, the traders have an objective of income generation with a timeframe of 4-5 weeks (derivative expiry) at max. India has a time correction of 18 months amidst all the negative newsflow of the Russia-Ukraine war, sharp monetary tightening by global central banks, higher energy prices etc. Indian markets now look better on absolute valuations.

The key issue impacting markets is the continuous selling by FPIs (higher interest rates in the US lead to higher hurdle rates for equity investing). While FY23 showed Indian investors' ability and willingness to buy, we need to see how FY24 plays out on demand and supply market dynamics, especially in the context of higher interest rates that can influence asset allocation.

Companies with earning resilience and cashflows may have better investment opportunities at present. Small cap as a segment could emerge as a beneficiary of any reversal in monetary policy stance by RBI.

Historically we have seen that markets when in consolidation, are a perfect case of buying equities as an asset class. When investing over a 3-5-7 years timeframe, Large, Mid & Small as a category may give reasonably similar returns, especially when considering associated volatility. However, if investors believe in fund managers' ability to make moves within large, mid, n small-cap segments, then mandates like Flexi Cap & Focused funds could be suitable for them.

We think the domestic rate cycle is close to its peak. While RBI, after its pause, will continue to maintain vigil over inflation and may have more rates, the markets have largely priced in such rate hikes, should there be any. With RBI projecting inflation of 5% in the second quarter of fiscal 2024, the time is now apt for looking into fixed-income products across all duration segments. With commodity prices, crude and agri commodities softening through the past few months, a sustained commodity slowdown may provide a respite to retail inflation.

• The bear flattening of the yield curve, especially in the 1-5 year segment, has largely happened, hinting at the possible end of the upward movement of the domestic rate trajectory.
• AAA credit spreads are very tight, and the probability of spreads increasing soon remains a distinct possibility.
• With US Fed trying to engineer a soft landing to the economy, there has been historically no precedence of inflation remaining high after the recession, which also bodes well for fixed income allocation.

Source: Bloomberg