New day, new high: Will stock markets maintain Thursday’s momentum?

Stock indices hit new records on Thursday, with mid-cap stocks joining the fray, reflecting rising risk appetite among investors betting on US interest rate cuts and earnings momentum in India.

The day saw a strong rally driven by a combination of factors: the expiration of weekly derivatives contracts, a rate cut in China, optimism ahead of a rate cut announced later that day by the European Central Bank, and hopes that the US Federal Reserve would soon follow suit.

On Thursday, the Nifty rose 1.9% to close at 25,388.90, while the Sensex rose 1.8% to 82,962.7, the highest percentage gain for both since June 7. Both the indices touched record intraday highs – the Nifty at 25,433.35 and the Sensex at 83,116.19. Meanwhile, the Nifty Midcap 100 rose 1.2% to 59,640.30, having hit a record intraday high of 59,697.75.

Apart from the big gains in Reliance Industries and banking stocks which supported the major indices, the sectoral performance was led by the Nifty Metal index which recorded a 3% gain followed by the Nifty Auto index with a 2% gain.

Will the rally last?

But a key question arises: will this growth continue or will it eventually peter out?

“The rally looks set to continue with India becoming a target for foreign investors,” said Taher Badshah, chief information officer at Invesco Mutual Fund. However, he believes India could now see a more mature rally as the interest rate cycle is expected to change, with some moderation in the industrial sector and increased interest in financials, technology, pharmaceuticals and consumer discretionary sectors, which were previously held back by inflation, he explained.

While Thursday’s rally was driven by a combination of factors, Sandipan Roy, chief investment officer at Motilal Oswal Private Wealth, expects the rally to continue, with occasional corrections along the way.

“A lot depends on earnings growth and flows into Indian equities,” Roy said. He sees earnings momentum continuing with Nifty earnings growing at 13-14 per cent compound annual growth in FY2025 and FY26. Moreover, domestic institutional flows remain strong while foreign flows could pick up pace with potential rate cuts on the horizon, he said.

The political situation in India has stabilised after the general elections, which is encouraging FIIs to consider long-term investments in the country, noted Vipul Bhowar, senior director, listed investments at Waterfield Advisors. “FIIs are finding undervalued, top-tier stocks in the banking and financial sector attractive. Moreover, new sectors and themes are now raising capital in the primary markets, generating significant interest from FIIs.”

After selling shares worth ₹904.19 crore on September 5, FIIs were net buyers in the last five sessions. On Thursday, FIIs bought shares worth Rs. ₹7,695 crore, while DIIs sold shares worth ₹1,800.54 crore, as per provisional data.

According to Bhowar, positive economic indicators, expected interest rate cuts and the current shortage of Indian equity owners point to a potential increase in FII investments.

The dollar may weaken

While a rate cut by the US Federal Reserve seems imminent at the policy meeting next week, further rate cuts over the next 6-9 months could weaken the dollar (as reflected in the dollar index) and increase allocation to emerging market equities in a risk-on environment, said Milind Muchhala, Executive Director, Julius Baer India. This could result in higher FII inflows in the coming months, especially given the extremely muted flows over the past few years and given the fact that India could potentially see a relatively higher allocation to the emerging market basket now compared to the past, with stronger growth prospects and relatively lesser conviction in China as an investment market.

Markets are already factoring in a 25 basis point interest rate cut by the US Federal Reserve in its upcoming policy and 75 basis points for the whole of 2024.

“However, if the Fed issues a slightly mixed/cautious commentary on its future rate cut path, it could dampen investor sentiment somewhat in the near term,” Muchhala said. “Also, given that Indian equities have recently seen healthy growth and are currently trading at a premium of over 10% to their historical averages, any correction in global markets or a slowdown in corporate earnings momentum could result in a modest downside to markets, which was widely expected; however, strong liquidity flows remain an upside risk for markets.”

In the past, delayed rate cuts have hurt the most expensive pockets — Nasdaq and Indian IT in 2000-01 and Emerging Markets and Indian cyclicals in 2008, Nuvama Institutional Equities said in a September 11 report. “Currently, Indian midcaps and cyclicals (autos, PSUs, industrials, metals) are such pockets — with valuations that have been high for decades — and we are very UW (underweight) in them. We maintain a defensive stance (OW — overweight — consumer, telecoms, pharma, insurance).”

The brokerage noted that the private banking sector is its only key cyclical group due to its significantly weaker performance, low valuations in a very expensive market and a narrowing earnings gap with the broader market.