Markets witness the longest losing streak in 28 years; is recovery in sight?

Indian benchmark indices have corrected more than 16% from the record-high levels achieved in September 2024. The pain in the broader indices is even more severe as the mid-cap and small-cap indices have corrected more than 26% from recent highs.

There are several reasons behind such a sharp and prolonged decline, including the rupee’s depreciation, muted earnings in H1FY25, stretched valuations and slowed economic growth. In addition, financial and monetary policy reforms in China came as a surprise, making China a more attractive investment destination for foreign investors at a cheaper valuation, which intensified the foreign fund outflows from India.

The NIFTY50 and SENSEX have corrected 5.6% in February, extending the losing streak to five consecutive months. Such a long period of decline was last witnessed 28 years ago, in 1996. However, markets posted a rally of nearly 53% six months after that.

Is there light at the end of the tunnel, and what are the bright spots for the markets from here on?

Valuations back in the saner territory

The primary reason for a sharp fall from the record high levels in NIFTY50 and SENSEX was lofty valuations. At its peak, the benchmark NIFTY50 index traded at a price-to-earnings ratio 24x, much higher than its long-term averages. In addition, the poor earnings in H1FY25 made the valuations look more unaffordable. Historically, valuations have always reversed to their average levels after being stretched for long periods. After a 14% correction in the NIFTY50, the current PE stands at 20x, lower than its 5-year median PE of 22.2x. Nomura, a global financial services company, forecasts the NIFTY50’s FY26 earnings at ₹1,286, making the 1-year forward PE of 17.5x at current levels, making it more affordable at forward earnings.

Earnings growth bottoming out

The Q3FY25 earnings season concluded with some respite as overall earnings fared better than Q2FY25. According to Ace equity data, NIFTY50’s consolidated net profit for the quarter grew by 16% YoY, much higher than 3.45% in Q2FY25. The broader NIFTY500 earnings, too, improved drastically in Q3FY25 at 18.45% YoY compared to flat earnings growth in Q2FY25. The overall earnings highlight the strength of the rural economy, which performed better than the urban areas and helped earnings growth. The stronger-than-expected earnings growth will remain a major market tailwind once the external factors stabilise.

Budget’s consumption boost

The Union Budget proved to be a major boon for middle-class consumers as the tax exemption limit was increased to ₹12 lakh. This led to the short post-budget rally in the markets, which fizzled out sooner than expected as external factors weighed on market sentiments. The government will reportedly forego tax revenue of ₹1 lakh crore due to the tax exemption. This move is expected to have a 5x effect on the economy and thereby boost earnings growth for the companies. As the earnings start to show the actual impact of the budget changes, markets may see a sharp reaction on the positive side.

Macro-indicators on strong footing

The key macroeconomic indicators signal a strong revival in economic conditions in H2FY25. First, the Q3 GDP numbers picked up from lower levels at 5.4% in Q2FY25 to 6.2% in Q3FY25. Second, core CPI inflation is near the targeted range of 4% after being on the higher side for two months. Third, the services PMI rose to the highest level in six months at 61.1, indicating a revival in the services sector. The composite PMI for January saw an uptick at 60.6 compared to 57 in the previous month. Fourth, the government capex has finally picked up in Q3FY25 as industry reports suggest the government expenditure is up 48% from the prior quarter, indicating new order announcements in the various sectors. Lastly, the 25bps cut in the interest rate will also aid credit growth back on track to double digits.

Despite a sharp drawdown in the benchmark indices, the underlying macro indicators point towards an imminent recovery in economic activity. With favourable budget announcements and capex pick-up, markets are poised for a turnaround in the coming months.