Indian Stocks' Next Leg Of Rally Hinges On Revival Of These Underperforming Sectors

India's equity gauges' have taken some steam off its record rallies, with the next phase dependent on underperforming sectors like financials, consumer discretionary, and information technology stocks.

These sectors received a further boost from the Union Budget unveiled by Finance Minister Nirmala Sitharaman on Tuesday.

The government emphasised focusing on India's youth via skilling programmes while boosting consumption through changes in tax cuts and enabling higher exemptions, among other changes.

The gauges of consumer companies, financials, and bank stocks have only seen single-digit returns and have underperformed the benchmark indices so far this year. While Nifty FMCG has returned 9.5%, Nifty Bank and Nifty Financial Services have risen by a mere 7% and 8.5%, respectively.

The catch-up rally in the technology stocks to the benchmarks that begin with the first-quarter earnings is likely to continue going forward.

Although rural consumption has faced challenges due to inflation, the improvements in demand bode well for the next two to three years, according to Kunal Shah, senior research analyst at Carnelian Asset Management & Advisors.

High deposit costs are hurting the banking sector's profitability growth, but Shah believes the US's easing interest rate environment is helping the IT sector's margins.

Brokerages like Morgan Stanley and Nuvama Institutional Equities are 'overweight' on the financials, consumer discretionary, industrials, and technology sectors.

India's benchmark indices—the NSE Nifty 50 and the S&P BSE Sensex— have risen 12.3 and 11%, respectively, making them the fifth and sixth best performing Asian indices.

To reduce the tax burden on the middle class and boost disposable incomes, the government announced changes in the income tax structure and an increase in the standard deduction from Rs 50,000 to Rs 75,000.

Higher-income tax exemptions and reduced import levies on select items like gold and silver are expected to enhance consumer spending, benefiting consumer staples, jewellery companies, and two-wheeler makers.

The Rs 2.6 lakh crore push for rural development will uplift rural communities and enhance agricultural productivity, which will benefit consumer companies.

Multinational companies in the FMCG space are up and running and will keep climbing, market veteran CK Narayan told NDTV Profit. "I would definitely concentrate on big FMCG names, as there is a tremendous focus on rural, and that ought to benefit two-wheeler companies."

Following a rural-focused budget, the demand for FMCG is likely to remain strong in the medium term, according to Rupak De, senior technical analyst at LKP Securities. "Additionally, the technical chart of the Nifty FMCG index has been catching up and appears very much ready to outshine the Nifty."

According to Motilal Oswal Research, fiscal 2025 will be an inflection year for earnings growth. The brokerage expects the banking sector to post a 16% compound annual growth rate over the financial year 2024–26.

"Interestingly, we believe that fiscal 2025 is going to be an inflection year as earnings growth after some period of moderation bottoms out in the second half and thereafter begins to accelerate in the second half of fiscal 2025." The first-quarter earnings of top lenders like HDFC Bank Ltd. and Kotak Mahindra Bank Ltd. were in line with analysts' expectations.

Given the budget announcements, rate-sensitive banks and financial stocks will be beneficiaries as bond yields decline and rate-cut possibilities rise, according to Jefferies.

The reintroduced credit-linked subsidy scheme will positively impact affordable housing financiers, according to Jefferies. "The initial provision of Rs 4,000 crore should get scaled up over time."

But gold financiers like Muthoot Finance Ltd. and Mannapuram Finance Ltd. will be negatively impacted by a reduction in gold prices due to a markdown in asset values.

The Bank Nifty is likely to continue underperforming in the short term as the chart has already started falling below its medium-term moving average, De said.

India's information technology stocks, which have been underperforming the benchmarks, played a catch-up rally following positive guidance and earnings by top players.

Tech stocks remained unharmed in the budget, and Narayan predicted a continuation of the recent rally in this space. He said that this space may be a good bet and would stick with industry leaders.

FIIs bought information technology stocks worth $331 million in July, leading the rally in the benchmark NSE Nifty IT, which rose by 8.53% during the month.

Overseas investors are piling on to tech companies amid hopes of a demand revival presented by the companies, following better-than-expected results for most of them.

The earnings cut cycle for the IT sector is largely behind, Shah said. "We are now seeing an uptick in margins, aided by the easing interest rate environment in the US."

The long-term chart of Nifty IT has given a strong breakout, suggesting that outperformance in the IT space is likely in the medium term, according to De.