The market is interestingly poised. The relentless FII selling, which contributed substantially to the sharp correction in the market, appears to be over. It can be argued that the market has bottomed out and recovery is likely despite potential headwinds and the volatility that it might trigger.
The downturn in the Indian stock market which began in October 2024 coincided with the downtrend in growth and corporate earnings. The post Covid-crash rally, which took the Nifty from 7,511 in March 2020 to 26,277 in September 2024, had fundamental support from GDP growth and earnings. During the three years from FY22 to FY24 GDP grew by 9.7 percent, 7.6 percent, and 9.2 percent, respectively. Growth was accompanied by earnings growth, too, which averaged above 20 percent during this period. The sharp deceleration in growth in Q2 FY 25 to 5.4 percent (later revised to 5.6 percent) turned out to be the fundamental trigger for the sharp market correction since October 2024. The earnings downgrade for FY25 from the initial estimates of around 15 percent to about 7 percent subsequently accelerated the market downtrend.
Economists have been debating whether this dip in growth is cyclical or structural. It is true that some structural factors have contributed to the growth slowdown; but the slowdown is largely cyclical. Fiscal and monetary restrictions mainly contributed to the cyclical growth slowdown. Now we have important macro evidence that indicate growth recovery.
Domestic tailwinds
The significant macro shift has happened in CPI inflation. Inflation has been steadily trending down from a peak of 6.2 percent in October 2024. Though trending down, it has been ruling above the RBI’s target of 4 percent till February. The February CPI print has come at 3.61 percent. Along with this the IIP in January has spurted to 5.1 percent. This healthy inflation- growth balance has set the perfect setting for a rate cut by the MPC in April, which can further boost growth, going forward. Q4 FY25 GDP growth is likely to be around 7 percent paving the way for earnings upgrade from Q1 FY26 onwards.
With market valuations now in tune with long-term averages, and attractive in many segments, these positive macro trends have triggered a stock market rally. But there are strong headwinds lurking on the horizon.
Global headwinds
Trump tariffs imposed on Canada, Mexico, China, and the European Union have invited retaliatory tariffs. President Trump’s strategy is to threaten countries with tariffs and then negotiate for a better deal for the US. But this strategy has not been working as President Trump expected. Consequently, he has been flip-flopping by announcing tariffs, then freezing them after a few days, reimposing the tariffs again, then having a rethink and exempting certain commodities from tariffs like automobiles from Canada and Mexico. This flip-flopping on tariffs, unprecedented and inconsistent, has created a highly uncertain global trade environment that will impact global trade and global growth. The US, too, will be impacted.
An inevitable consequence of this trade war would be a spike in inflation. The Fed, which has succeeded in bringing down inflation in the US from above 9 percent in mid 2022 to 2.6 percent now will be in a difficult situation. The year 2025 began with three rate cut expectations from the Fed. In the March 18th policy announcement, the Fed indicated only two rate cuts. Importantly, the Fed lowered the US growth rate in 2025 to 1.7 percent and raised the PCE inflation target to 2.6 percent. If the trump tariffs raise inflation in the US, the Fed might even turn hawkish. The Fed will be in a tight spot if instead of inflation, the US economy heads towards stagflation. This can lead to further sharp corrections in the US stock market, which is priced to perfection now. A bearish phase in the mother market is a headwind for all stock markets. Therefore, even though the domestic tailwinds are strong, they may get neutralized by the global headwinds.
Safety is in domestic consumption themes
With global uncertainty reigning supreme, safety is now in domestic consumption themes which will be least impacted by the trade war. Financial services, hotels, FMCG, telecom, select autos and aviation are safe sectors. IT is already down on growth concerns in the US and pharma, despite strong fundamentals, is jittery on reciprocal tariff concerns expected to kick in from April 2nd onwards. The investment strategy can be tweaked after details of the reciprocal tariff policy are known.
