The Wrap🌯 17 Dec 2023 | Peak Rates
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A Dovish Fed, Rate cuts in 2024, Nifty IT Index and large caps rallies, FII money keeps pouring in
If you have been in the market since 2020, you would have come across the below chart.
It’s the chart of interest rates set by US Federal Reserve, also known as Fed Funds Rates. Much of the conversation for last few years has been around inflation and how Fed was pulling off the fastest and largest ever interest rate hikes in its history (notice the steep incline from March 2022).
Given the rampant inflation post-pandemic, the Fed had to engineer a brave maneuver to cool down an over heated economy with the main tool in its arsenal - the interest rates. US economy went from 0.5% Fed Funds rates in March 2022 to 5.5% as of Dec 2023, a 500 basis point hike in just 22 months!
In investing world, interest rates are like gravity. The higher they are the more force they have to pull valuations down and suck out excess money from the market.
As both, the inflation and US economy cools down, the Fed is now dealing with a different kind of risk - the risk of doing too much. If they continue to increase interest rates while inflation keeps falling, the highly desired soft-landing of the economy (soft landing refers to bringing inflation under control without disrupting growth in an economy) may be in jeopardy.
So it was largely expected by the market that Fed at some point in 2024 will start cutting rates in order to not risk “the doing too much” scenario. What the market did not expect, was a highly dovish Jerome Powell and Fed effectively stating that market should expect not one, not two but three rate cuts in 2024.
This unexpected but very much pleasant surprise lead to huge rallies this week not just in US but also in India.
In the US, Nasdaq, S&P 500 and Dow Jones were up anywhere between 2.5 to 3.5% for the week. While in India, our very own Nifty managed to eek out a 2.32% return with Small cap index advancing by 3.35% and Mid cap index by a healthy 2.67%.
As expected, not a single sectoral index ended in the red with the best performance coming from the large cap IT companies. The Nifty IT index returned a marvelous 6.73% for the week.
Below is the Nifty IT index chart with its clean breakout this week.
I expect this performance to continue from the large cap IT companies for three main reasons:
They are trading at or below their long term average valuations while rest of the market isn’t
As interest rates decline in US, the corporates that were putting off tech project expenses for much of last two years will start to greenlight them helping earnings growth return to the Indian IT service sector
As interest rates decline, so will the yields on safer risk free instruments like US bonds which will leads to massive outflows of money from the bond market to emerging markets like India. Indian IT and large caps are the obvious choices for much of these foreign investment flows
The last point also brings me to my other somewhat educated guess. Large cap companies may continue their rally as foreign investors chase Indian stocks.
A lot of FII money was sitting on the sidelines until last week’s Fed meeting which is now rushing in to India. FIIs have now invested close to ~30,000cr this month alone and we still have close to 2 weeks left. The only other time FIIs invested more money in a single month was in Feb 2021.
India while being worth USD 4 Trillion, is not a very liquid market and as such has limited options for investors with deep pockets.
Out of ~4700 listed stocks only 443 companies have a market cap greater than 10,000cr. That’s less than 10% of the market.
This is how these 443 companies are distributed.
When FIIs want to invest, they do not have a lot of options but to look for large caps in order to avoid liquidity risk in their investments.
The second reason why I think large caps will lead the market from here on is the gap in valuations between large caps and small cap companies. While Nifty is making new highs and you might be concerned about a sell off, let me point you towards the valuation of Nifty 50 vs history.
The current PE of Nifty 50 is 22.36, this is in the median long term range. We aren’t even in the 1 standard deviation extended range so far.
So if you’re worried that there will be a large sell off in the market, I can assure you this much that it wont be because of valuations.
The only data point that I dislike in all of the above is our current market breadth.
The entire market continues to trade in top percentile range. If FII money does keep pouring in, I expect this to get even higher.
As I close this segment, my only piece of friendly advice to you is this - Dont be a bear in this market.
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