Unhedged Position: There Is More Pain Left For The Indian Market

Indian stocks are at a stage where frustration has overtaken optimism. The Nifty is at levels first seen in early 2024. Many individual stocks, including big names such as HDFC Bank, HUL and ITC, are trading at levels last seen five to 10 years ago.

It's logical to think the market could now enter a long-term bull market. Stocks move in cycles: periods of sustained price appreciation often follow prolonged consolidation. But even if that happens, it's good news only for those sitting on the sidelines or holding dollops of cash to deploy.

Before we start crystal-ball-gazing about what's in store for equities, it's worth reflecting on how we got here, especially given the relatively solid macroeconomic backdrop, and what it means for the future.

There are three trends at work.

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One, mean reversion

Over the long term, stocks tend to track the growth in corporate earnings, with nominal GDP growth serving as an important macroeconomic anchor. 

In India, nominal GDP growth has historically been in the 10-12% range, while long-term earnings and equity indices have grown at 12-14% over any long-term period comprising of a decade or more. Of course, the starting point matters. A decade that begins with stocks severely overvalued, such as in 1992, will produce a very different outcome from one that begins with stocks undervalued, as in 2001-02.

This means that after markets double or treble, as they did between 2020 and 2024, they can enter periods of underperformance as earnings catch up with valuations or valuations themselves moderate.

Two, this time is different

The benefits of industrialisation and globalisation that powered Western economies for decades are fading. Slower growth, ageing populations and a shift towards deglobalisation are changing the economic landscape.

In response to this, global central have launched a money printing exercise whose scale does not have a parallel in history.

One could make the case that in a slowing world, a high-growth country like India could deserve premium valuations.

However, with central banks playing a dangerous game, the liquidity-led equity rally that has become the new normal could reverse quickly at the first sign of big trouble.

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Three, superintelligence

The advent of AI is likely to create a disinflationary cycle as productivity gains lower the cost of producing goods and services.

This, of course, means outsized gains for those owning the means of production, but it isn't great news for prospects of a broad-based consumption cycle. AI-triggered job losses and wage pressures could weaken consumption further risking a vicious cycle. And then there are tail risks, including AI going rogue and the possibility of social unrest.

Currently, global equities are powered by the AI boom, even as many analysts believe India, lacking a strong AI play, is suffering because of it.

But once the dust settles on the AI boom, and the long-term effects of AI seep into the global economy, disinflationary pressures could inhibit revenue growth across all economies, India included.

The Bottomline

It is said that in a bear market, once stocks have taken enough of a beating, they become immune to bad news. Similarly, at the peak of the bull market, they stop responding positively to good news.

Global equities, India included, have been in a multi-decadal bull run.

Should any of the above three factors pan out, valuations could moderate.