This Article was originally published in The Global Analyst

This is the time of the year when you start crystal gazing to see how markets will perform in 2023. Indian stock market was a complete exception to global trends in 2022. Indian benchmark indices (Sensex and Nifty) have hit life-time highs in a year marked by global meltdown. Nifty is up 6% for the year (till 20th December) while all other markets including S&P 500, MSCI Emerging market index, etc. went through a tough bear market. India demonstrated efficient COVID management as it did not appear as draconian as China which enabled broader economy to jump back swiftly. Also, the inward looking Indian economy with not much of export dependency (unlike China) saw to it that the economic engine continues to brim on the back of domestic consumer support. To top this, the strength of retail investors who have now embraced Systematic Investment Plan (SIP) in big measure made sure that the liquidity tap is kept open even in the aftermath of severe pulling out of funds by foreign investors. It is quite possible that these factors can explain the performance of Indian equity markets in 2022.

With this background, we can now focus on what is in store for 2023 in terms of expectation.

Of market drivers and signals

In my framework, I considered 6 key variables and rate them across positive/ neural/negative to get a sense of the overall outlook.

1.     Economy: There are many legs to the economy and I have identified 7 to focus. Among these, let us first focus on the positives.

At the broad level, the real GDP growth is expected to slow down a bit to 6.1% in 2023 from 6.8% in 2022 as per IMF. Other global forecasts like Amundi (5.6%) and Barclays (5.1%) may be even a tad lower than IMF. However, in relative terms, the Indian growth appears better than other developed and developing markets. The Current account worsened in 2022 (-3.5% of the GDP) on the back of high energy prices. However, India’s deal with Russia saved the day to an extent and the Current Account is now expected to turn positive to 2.9% of GDP for the year 2023.  The credit growth (a key measure of economic activity) exhibited good strength in 2022 at 14% and as per Fitch is expected to get better at 17% for 2023. Inflation is a hot topic for the world in 2022 and can count as the single spoiler of all equations. Advanced economies (read US and Europe) inflation now looks more like emerging markets and Fed has to be its aggressive best to tame it. Eurozone inflation is expected to be 7% in 2023 while that of US is expected to come down to 4.1% in 2023 after clocking 8.1% in 2022. CPI estimates for India stand at 4.9% to 6.3% depending on where you look. But these numbers appear very reasonable given the global trends in inflation.

In terms of negatives for the economy, I would flag the sharply reducing forex reserves and fiscal deficit. On the forex reserves, we have seen a depletion of more than $100 billion in 2022 and the reserves stand now at $564 billion compared to $635 billion in 2021. That is the price RBI has to pay to defend the currency which depreciated by 11% against the US Dollar in 2022, still better than other emerging market currency depreciations. Morgan Stanley now expects Rupee to appreciate by 6% in 2023. The rapid fall in forex reserves is indeed a negative for an economy like India. However, the performance of Rupee can be categorized as neutral. The other negative is the outsized fiscal deficit that the country is going through. After clocking nearly 10% of deficit in 2022, 2023 appears no different with a projected deficit of 9% of the GDP. In normal times, such high levels of deficit would have warranted serious credit rating actions but in COVID and war times, all are forgiven. However, the uncontrollable fiscal deficit is a serious negative.

My overall assessment of the economic potential of India for 2023 is POSITIVE. 

2.     Earnings: In the long-run the only thing that matters for stock market is the earnings growth. Due to COVID, Nifty 50 EPS growth showed very high volatility (-15.4% in 2020 followed by +98% in 2021). However, EPS growth stabilized to 16% in 2022 and Citi’s forecast for 2023 stands at 16.4% and 28.2 % for 2024. This makes me to believe that assessment for earnings growth is POSITIVE.

3.     Valuation: India’s P/E ratio stands at 22 in 2022 though down from 24 in 2021. However, global P/E ratios all appear very reasonable after the bear market meltdown and in that context India’s P/E ratio appear very excessive. The forecast by Citi is that it is likely to moderate to 18.9 in 2023 and to 8.8 for 2024 given the strong EPS growth. While the outlook for 2024 appears very reasonable, the outlook on valuation for 2023 looks expensive and therefore the assessment is NEGATIVE.

4.     Foreign Portfolio Investors (FPI’s): FPI’s found immense value in US and Europe after the bear markets and therefore money got pulled out of markets like India. Though towards the end some money found its way back to the market, generally throughout 2022, foreign investors were mainly sellers in India. FPI showed a negative balance of Rs.133,963 crores in 2022 as against a positive flow of Rs.50,089 crores in 2021. FPI’s own nearly 19% of shares in Indian companies. Given the expected volatility in global markets, I see the same trend for 2023. The assessment therefore on this count is NEGATIVE.

5.     Domestic Institutional Investors (DII’s): Institutional investors in India like LIC, mutual funds, etc. are indeed active and contribute to the overall strength. However, their asset allocation favors more of debt except for equity mutual funds. To compensate for the outflow from FPI’s, DII, s invested Rs.251,000 crores in 2022 and was instrumental in holding up of the market. They hold nearly 20% of shares in Indian companies something very similar to FPI’s. The role of domestic institutional investors largely remains POSITIVE for now.

6.     Domestic Retail Investors: The biggest surprise for Indian capital market continues to be the growing retail investors who embraced active trading during COVID lock down in 2020 and 2021 and now turned to long-term investors primarily through SIP’s which guarantees regular liquidity regardless of market conditions. Retail investors account for 7.3% in terms of share ownership in Indian companies and I expect that to grow significantly over time. The continuous presence of retail investors in the market is a huge POSITIVE for market outlook.

What do the indicators suggest

In conclusion, given the fact that 4 out of 6 factors are positive with one neutral, the overall outlook for Indian stock market in 2023 appears positive. Market appreciation from these levels when indices have reached historic highs can be tricky. Such an appreciation can come mainly through market cap expansion triggered by earnings expansion. The scope for upward P/E rerating appears low and therefore earnings expansion seems to be the key. Any negative surprises on this can induce a great deal of volatility. 

Global opinion about Indian equity market prospects are sharply divided with Citi predicting Nifty to end at 17,700 while Goldman Sachs expects Nifty to end at 20,500. I would expect Nifty to close anywhere between 21,000 to 23,000 as a base case scenario. Within this, sectors like Banking, Financial services, Capital goods and IT can be favored. 

In any case, equity asset class is characterized by high volatility and one can beat this danger only by constantly investing in the market at periodic intervals. The key is to be invested in the market and avoid trading.