Nifty scaled a new lifetime high on improving domestic macros and hopes of RBI pivot.

For FY: 24-25, Nifty EPS may grow by around +10% (CAGR) against +8% in FY23; Nifty may scale around 19250 shortly and 21175 by Mar’24

India’s benchmark stock index Nifty closed around 18972.10 Wednesday, after hitting a session/lifetime high of 19010.00, surged almost +2.36% in June (till date) and almost +10% since Apr’23 primarily on FII boost amid improving domestic macros, the appeal of Modinomics, India’s 5D (demand, demography, democracy, deregulation, and digitalization) and political & policy stability. India’s Dalal Street was also boosted by positive cues from Wall Street on easing of Russian regime change tension and hopes & hypes of Fed pivot. The market is now also expecting a similar RBI pivot.

The Indian market was also boosted by the optimism of Modinomics amid a ‘historical’ visit by Indian PM Modi to the U.S., where both sides signed many business/military deals, expected to boost both the economies (world’s two largest ‘democracies’). The market is also upbeat about PM Modi’s diplomatic strategy/ability to keep both U.S. and Russia happy, ensuring India’s interest first. Thus Indian capital market is also enjoying a valuation premium among comparable emerging market economies and FPIs are now scrambling for India, considering the macro/policy/political stability along with well-managed blue chip companies, improved corporate governance, strong banks & financials, and deleveraged corporates. India is now enjoying the benefit of a vibrant economy and democracy, a rare combination in the EM world.

For the last 30-days, the Indian market was boosted by interest rate sensitive realty, automobiles (hopes of RBI pivot), FMCG, infra, Pharma, banks & financials, metals & media, while dragged by techs/IT, and selected PSU banks. On Wednesday (28^th June), Nifty was also boosted by RIL and Adani's group of shares (after stake buying by angel investors led by GCQ).

At around 866.30 TTM EPS (FY23), the current Nifty PE is around 21.90 against the average fair PE of 20:

So far, the Nifty EPS trend in Q4FY23 is subdued at around 866 against Q3FY23 levels of 850. The FY22 Nifty EPS was around 809, while the market is expecting around 875 in FY23 (Q4FY23), i.e., an annual growth of around +8%. For FY23, at around 875 estimated EPS and an average PE of 20, the fair value of Nifty should be around 17500 (for Mar 22).

At the present trend rate, the projected FY24 Nifty EPS maybe around 962 (assuming +10% annual growth), and at an average PE of 20, the projected fair value may be around 19250. Further, if we assume 10% annualized growth in Nifty EPS in FY25 (depending on actual Fed/RBI rate action, Russia-Ukraine war, and inflation trajectory), projected Nifty EPS may be around 1059, which translates to a fair value of Nifty around 21175. As the financial market usually discounts 1Y EPS in advance, Nifty may scale 21175 by Mar’24.

The subdued Nifty earnings are due to lingering global macro-headwinds, geo-political tensions, and resultant sticky elevated inflation, both locally and globally and higher borrowing costs are affecting discretionary consumer/corporate spending, affecting earnings. If inflation comes down and RBI/Fed goes for pause/pivot, i.e., rate cuts in early FY24 (ahead of the general election), Nifty EPS may grow around at least +10% CAGR rate on an average considering huge fiscal/infra stimulus, growing affluent middle class, and higher USDINR (growing policy/macro divergence between RBI and Fed)-positive for export savvy Nifty blue chips (almost 60% of Nifty earnings comes from export).

India is now enjoying scarcity premium not only among EMs but also DMs due to political & policy stability (Modinomics), the mantra of reform & performance, and the appeal of 6D (development, demand, demography, democracy, deregulation, and digitalization). India has a strong banks & financial system due to a strong capital buffer and regulatory system. India’s low external debt and manageable trade deficit are a huge advantage compared to many EM peers.

But going ahead, India also has to bring proper political reform, especially on the political funding aspect, proper policy for population control, and more targeted infra stimulus (transport-specially railways and social infra-especially quality medicare and education). Thus the scope for future improvement in GDP and GDP/Capita is immense. This, along with a deluge of quality companies, good business models, growing deleveraging, and impeccable/credible management, the Indian stock market may outperform not only its peers (EMs) but also many DMs.

The next move of Nifty will depend upon RBI/Fed rate action:

Overall, the U.S. labor market and core inflation trajectory are still hot enough for another two Fed hikes. Fed never surprised the market with its rate action. As the overall labor market and core inflation are cooling gradually, while the Fed repo rate at +5.25% is now near the mid-zone (+5.50%) of the restrictive zone (5.00-6.00%), Fed goes for a pause on 14^th June, but also projected (June SEP) for another two hikes in H2CY23 to manage inflation expectations.

The U.S./Fed’s average underlying core inflation is now around +5.0% (CPI+PCE), and at +5.25% repo rate, the real rate is now positive by around +0.25% and just below the middle range of the Fed’s restrictive zone (5.00-6.00%). The May core inflation data came largely in line with market expectations just a day before Fed’s MPC date. But even if the May core inflation data unexpectedly surged, Fed may not alter its hold decision to shake the market just a day ahead of the MPC date.

As per Taylor’s rule, for the US:

Recommended policy repo rate (I) = A+B+(C+D)*(E-B) =0.00+2.00+ (0+0)*(6.00-2.00) =0+2+4.00=6.00%

Here:

A=desired real interest rate=0.00; B= inflation target =2.00; C= permissible factor from deviation of inflation target=0; D= permissible factor from deviation of output target from potential=0.00; E= average core inflation=6.00% (for 2022)

Looking ahead, Fed may consider a quarterly/3M rolling average of underlying core inflation and outlook. As Fed is trying to bring down core inflation towards +2.0% targets without causing an all-out recession (soft/softish landing), Fed may henceforth move only in every alternate meeting by +25 bps rather than in each consecutive meeting for a calibrated action after increasing the rate to restrictive zone-real positive.

Fed is slowing down from +75 bps to 50 bps and then 25 bps from every meeting to possibly every alternate meeting in H2CY23. Fed is trying to bring down core inflation towards +2.0% targets without causing an all-out recession (soft/softish landing). Thus in its June SEP (dot plots), Fed forecasted another 50 bps rate hike for H2CY23 to control market, bond yield, and also inflation expectations.

Looking ahead, Fed may try to balance the financial/Wall Street stability and price stability by expressing intentions to move for any rate action in July and November. Also, Fed has to ensure lower borrowing costs for the U.S. Government (Treasury) endless deficit spending and mammoth public debt of almost $32T. The U.S. has paid around 9.5% of its revenue as interest on public debt against China/EU’s 5.5%. This is a red flag, and thus Fed has to operate in a balancing way while going for calibrated hiking to bring inflation down to target, ensuring a soft and safe landing.

India’s core CPI continues to be sticky around +6.00% since Jan’21 and consistently above +4.0% targets even before COVID. Like Fed, RBI is also far behind the inflation curve for a long. Thus RBI wants to ensure a real positive rate, by around +100 bps (restrictive levels), wrt at least average core inflation. RBI continued to tighten to keep interest rate/bond yield differential and also USDINR under control, which will also control imported inflation and manage overall price stability. RBI has to tighten in a calibrated way to bring inflation down by curtailing demand, i.e., slowing down the economy to some extent without causing an all-out recession for a safe and soft landing.

As a Central Bank, RBI’s job is to hike rates well into the restrictive zone to curtail demand so that it can match with currently constrained supply, resulting in lower inflation. RBI as-well-as Fed, has done their jobs almost fully and may hike once/twice more in H2CY23 and a long pause thereof at least till H1CY24 before any plan to cut (if core inflation indeed goes down towards target zones).

In the last financial year (FY23), RBI hiked the +250 bps repo rate, and core CPI declined -100 bps from around +7.0% to +6.0% on average; Indian 10Y bond yield also moved up around +100 bps from around +6.0% to 7.0%. At this run rate, if RBI goes for a pause around the 6.50-6.75% repo rate, the core CPI may further fall to around +5.0% by Mar’24 and +4.0% targets by Mar’25.

In India, a higher interest rate may not contain core inflation alone for various reasons, like the government’s indirect control over domestic fuel (petrol & diesel) as per political compulsion. In the last year, global crude oil prices tumbled from around $117 to $67, and India is buying a major portion of Russian oil significantly cheaper than the market price. But the Indian government has not allowed OMCs to reduce retail prices of petrol & diesel apparently to ensure that OMCs remain profitable (after adjusting any previous losses). The government is also collecting huge tax revenue from fossil fuel, which is helping in deficit spending (led by infra spending). The Government may allow OMCs to reduce prices ahead of any major state election and also the early 2024 general election.

In any way, as the government has not passed the benefit of lower crude oil prices into the retail price of petrol & diesel, India’s core inflation remains elevated and sticky around +6.0% for most of 2022 and even early 2023. Also, in India, there is significant wage inflation for not only government employees (through DA) but also for private employees, especially corporates; i.e., the wage increase is higher than the productivity gain. This in turn, is also resulting in higher goods and service prices, creating a cycle of higher inflation.

Also, India’s fiscal stimulus, i.e., deficit spending and grants by the government, is creating inflation directly/indirectly (through a systematic corruption route). India’s almost 30% population, equivalent to almost the U.S. population, may belong to the high middle class/rich category due to good salary income (often more than productivity levels), corruption /unaccounted money, vibrant capital/real estate market, and growing startups and digital ecosystem (You tubers). Most of these categories of the high middle-class population are rich in cash and generally don’t need to borrow heavily for consumption or investment.

Thus despite higher borrowing costs, overall consumer demand in India remains resilient, and so core inflation remains elevated and sticky around +6%, which is quite bad for the rest 70% of the population, which belongs to the lower-middle class or under APL/BPL. This 70% of the population also forms a formidable vote bank for any political party, and thus, any government, which is not able to manage inflation consistently, will be vulnerable in the next election (as seen in the recent Karnataka state election, where ruling party BJP/Modi had suffered the formidable loss despite their best campaign effort). The same is true for employment.

As per Taylor’s rule, for India:

Recommended policy rate (I) = A+B+(C+D)*(E-B) =0.50+4+ (1.5+0)*(6-4) =0.50+4+1.5*2=0.50+4+3=7.50%

Here for RBI/India:

A=desired real interest rate=0.50; B= inflation target =4; C= permissible factor from deviation of inflation target=1.5 (6/4); D= permissible factor from deviation of output target from potential=0; E= average core CPI=6 (for CY22)

Thus assuring the estimated average core inflation is around +5.00% in CY23, the restrictive range of the RBI repo rate may be around 6.50-7.50%. If Fed continues to hike +50 bps in H2CY23 (even after June’23 pause) to +5.75% by Dec’23 (in case U.S. core inflation surges more), then RBI also has to hike (under still elevated/sticky core inflation). Thus RBI may like to keep the repo rate at 6.75% in CY23 by hiking once in Dec’23 if Fed indeed goes for two hikes in July and November; otherwise, RBI may not hike further in 2023 (even if Fed goes for only one hike in July in H2CY23).

As USD is the reserve/global currency, every major Central Bank has to follow Fed action to maintain bond yield/currency and policy differential (whatever may be the inflation/growth narrative) to control imported inflation. Thus RBI again reminded the market on the 6^th April MPC statement about the real rate of interest of +4.50% in Feb’2019 (when RBI started the pre-COVID rate cut cycle to support economic growth); in Feb’2019, RBI repo rate was +6.50%, while headline CPI was around +2.00%, but core CPI was around +5.25%. Thus the actual real rate of interest about core CPI was around +2.25% in Feb’2019 against Rajan’ (former RBI Governor) preference of around +1.50% (1.00-2.00%).

Under Governor Das and Modi admin, RBI may prefer to keep the real rate of interest around 0.50-1.50%; as India’s core CPI is now averaging around +6.00%, RBI may keep the terminal rate between 6.50%-7.50% in the coming days depending upon the actual Fed rate action and domestic core inflation trajectory. As there are a series of state elections in 2023 and also a general election by May’24, RBI may keep the terminal repo rate around 6.50-6.75% if Fed does not go beyond +5.75% and India’s core CPI stays below +6.50%.

Overall, RBI is quite optimistic about India’s GDP growth but is still concerned about elevated sticky core inflation. But RBI is also quite optimistic about maintaining India’s price, financial, and growth stability through its calibrated policy action. As India’s core CPI is still substantially higher than targets, while real GDP growth is almost in line with the potential trend, RBI is still open for another one/two calibrated +25 bps rate hikes. If Fed indeed goes for another two rate hikes in H2CY23 for a repo rate of +5.75%, RBI may go for at least another +25 bps rate hike by Dec’23 for a corresponding repo rate of +6.75%.

If Fed goes for only another rate hike in H2CY23 for a terminal repo rate of +5.50%, RBI may continue to hold at +6.50% in FY24. And if Fed does not hike more in H2CY23 and keep the terminal repo rate at present levels of +5.25%, then RBI may even go for a -25 bps rate cut in Apr’24, just ahead of India’s general election in May-June’24 to boost Dalal Street, economy, and risk on/feel-good sentiment.

Technical Analysis: Nifty Future (LTP: 18975)-EOD: 28/06/23

Looking ahead, whatever may be the narrative, technically, Nifty Future now has to sustain over 19100 for a further rally to 19200*/19300-19400/19750 in the coming days (Bullish side). On the flip side, sustaining below 19050-18875 Nifty future may again fall to 18700/18600*-18500/18275* and 18150/18100*-17925/17775 and 17550*/17300-17000/16800* and 16650* in the coming days (Bear case scenario).

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