Dear Investors,
The following chart depicts our returns viz BSE 500 TRI:
In this month’s newsletter, we will share some general musings on the market. Since it is the beginning of 2024, it is natural to ponder whether Indian equities will deliver positive returns this year. Of course, no one knows the answer to that and for a long-term investor, it should not be a matter of concern. However, we share the historical annual performance of BSE Sensex over the last 43 years. Sensex has delivered negative returns in 10 out of the last 43 years so the chance of positive performance is generally high at 75% in any given year. On the other hand, Sensex has been on its longest streak of consecutive positive returns over the last 8 years so the probability of this streak getting broken is high this year. It is up to you to be optimistic or pessimistic about 2024 performance.
The graphic below highlights how strong the inflow of funds from domestic investors (mainly MF SIPs) has been in the last 10K journey of BSE Sensex from 60K to 70K. The strong domestic investor inflow has completely nullified the negative impact of FPI outflows during this last 10K journey of Sensex. In fact, it is the first time in its history that Sensex appreciated by 10K despite strong selling by FPIs. This is truly a moment that shows the Indian domestic investors have arrived and fully control the direction of Indian equity market, which is no longer solely dependent on FPI inflows.
The chart below shows the composition of Indian household assets at end of March 2022. Even after the strong domestic inflow into Indian equities over last 3-4 years (refer to graphic above), equities just make up 4.8% of total Indian household assets. This is significantly lower than in the US, where equities make up ~25% of household assets. Moreover, if we look at the trend over last 15 years, the share of equities as % of Indian household assets has not moved up significantly. So, there is a large headroom for equities to gain popularity among Indian investors and increase its share of Indian wealth.
Source: RBI
Coming to current valuation, the charts below highlight the valuation of large cap, mid cap and small cap indices at the end of 2023. As expected, valuations of mid and small cap indices are at a premium to their long-term average while large cap valuation is at long term average level. Since March 2020, small and mid cap stocks have in general delivered much better returns than large cap stocks. As we are investors in small and mid cap companies, we have been cautious in our approach (we have discussed the same several times over the last few months). We are exiting stocks whose valuations have become too expensive and leave no room for further upside. Also, we have been cautious in deploying additional capital, that we are investing in few opportunities where valuations are still reasonable with decent growth prospects.
However, we do want to highlight that small and mid cap companies have delivered much better earnings growth in the last 3-4 years so the higher returns in these stocks is justified. This is because certain sectors like engineering & capital goods, real estate, textiles, building materials (except paints), manufacturing, etc, that have delivered the best returns since March 2020, mainly have only small and mid cap companies. These cyclical sectors performed quite poorly during the decade of 2010-20 but have revived since then due to pick up in capex, infra and real estate cycle. Moreover, in certain sectors like IT services, mid and small cap IT companies focusing on niche areas like ER&D services, outsourced product development, KPO, etc have delivered much better growth than large cap IT companies with broad based offerings. Overall, there has been a strong surge in listed corporate earnings over the last 3-4 years, so the premium valuation is arguably justified to a certain extent.
The chart above shows the trend of increasing share of listed companies in India’s total corporate earnings. This is because of 2 factors – one that we discussed already that cyclical sectors like manufacturing, commodities, engineering & capital goods, etc have really turned around since FY20. Most of the companies in these capex heavy B2B sectors are listed and hence led to increasing contribution of listed companies to Indian corporate earnings. The second factor is that Covid disruption was much better managed by large listed corporate players leading to market share gains by listed companies in most sectors. This has also led to increased share of listed companies in India’s total corporate earnings.
To sum up, 2024 comes with a mixed environment. On the one hand, valuations are stretched so we need to be careful while on the other hand, earnings prospects are still bright for several sectors so we feel one cannot completely sit out. So, it will be a challenging task for us and we hope to do our best.
Regards,
Prescient Capital