Market appears to be factoring in near-term peaking out of interest rates, possibly followed by a rate cut cycle after a span of stability in rates. For India, valuations are benign amidst supportive macro which provides comfort. Indian equities are trading at mean levels, both relative to long term averages (price to earnings, price to book, market cap to GDP), and relative to emerging and developed markets. Supportive macros (normal monsoon, benign crude and commodity prices, strong domestic capex triggers, continued traction in domestic economic activity levels, and softer than earlier anticipated global slowdown) provide comfort, hence we remain optimistic on Indian equities.
Compared to other nations, including the advanced economies, India is relatively better prepared to handle external shocks that could be created by the tightening of the monetary policy stance. We reiterate our observation that as compared to previous periods of hawkish policy stance, this time around, the inflation differential is in India's favour, due to which policymakers may not follow the Fed completely. India has been a fast-growing economy, even during the difficult times of the pandemic, underpinned by structural reforms, which should serve well ahead.
Strong fundamentals of the Indian banking system and unlikelihood of any system risk to it, positive trends from the Budget 2023, and persistent selling by FPI's being absorbed by domestic investors give credence to the long-term India story regardless of any near-term blips or volatility. Of course, the FII flow trend has reversed in the near-term as FIIs flows remained positive at USD1.9b for the second consecutive month in CY23. DIIs remained net buyers with inflows of Rs0.3b. Consumption remains K-shaped with rural growth yet to return. However, construction activity has become more broad based and upcoming elections should help boost public capex.
In this backdrop, we maintain our strategy of holding largely sector neutral portfolios to navigate this uncertainty. Domestic cyclicals such as auto and auto ancillaries, consumer durables, real estate and building materials, capital goods and engineering, infrastructure related sectors should do well. Within defensives, pharma and healthcare sector should do better as it comes out of a low growth phase. While the IT sector is facing a threat of global recession, post the correction the sector in the past 6 months, valuations are more reasonable now, leading us to have a neutral stance on it. We are also maintaining a neutral position in the financials space.