Quality stocks with strong fundamentals will likely outperform momentum-driven ones

The festive and ongoing wedding season, along with strong rural consumption, are boosting sectors like apparel, vehicles, and two-wheelers, while government spending needs to rise significantly to meet Budget targets and fuel infrastructure projects. These factors are supporting economic growth and the equity market.

The combined spending on festivals, weddings, and government is estimated to see a huge increase from Rs. 4.2 lakh crore in the first half (H1) of FY25 to Rs. 6.9 lakh crore in H2FY25. Additionally, higher rural wages are supporting discretionary spending, boosting demand for consumer goods.

Private sector capex is reviving with an improvement from Rs. 5.4 lakh crore in FY21 to Rs. 9.4 lakh crore in FY24. This was led by government incentive policies and demand recovery across sectors like oil & petrochemicals, power, telecom, and automobiles & ancillaries.

Meanwhile, as a result of the US-China tariff war, the former has reduced Chinese imports sharply from November 2016 to July 2024, benefitting India as an alternative manufacturing base.

In the current market, with price-to-equity (P/E) expansion being unlikely, investors could focus on companies with strong earnings potential. The era of 30% annual returns from small- and mid-cap stocks may be over, requiring a shift in expectations. Sectors like private banks, auto, telecom, pharma, and IT are trading below historical averages and offer value, while areas like Railways and defence may be overvalued. Quality stocks with strong fundamentals are likely to outperform momentum-driven ones. Strategic stock picking and sector rotation will be key to navigating the current market environment.

Here are some key themes that can drive the equity market in 2025:

Recovery of the Investment Cycle

India is entering a crucial multi-year capex cycle, set to drive significant economic growth. Corporate order books are expanding across sectors, reflecting the broad scope of this cycle. Project costs have risen to an all-time high of Rs. 55 lakh crore, suggesting a robust capex recovery. This has been fuelled by favourable policies and improved economic sentiment. The rise in combined capex of the government and listed corporates highlights India’s focus on infrastructure, industrialisation, and private-sector-led growth. The Centre’s increasing capex signals strong support for infrastructure development, aligning with the surge in corporate investment.

Penetration of Financial Services

Financial services is a diverse space with varying performance across subcategories. The gap between bank credit growth and deposit growth is narrowing, which could alleviate margin pressure. Banks have witnessed strong return ratios and improved capital adequacy, decreasing the need for fresh capital and helping to maintain shareholder value. Valuations within the banking sector remain attractive relative to the broader market, aligning closely with long-term averages for both public and private banks.

Technology: Cutting-edge Solutions

Spending on IT services is expected to improve, with higher spending on cloud services fuelled by scalability, cost efficiency, and agility. India is expanding its offerings in new-age services such as AI, blockchain, and cybersecurity, positioning itself as a key player in the global technology landscape. One of the key drivers for the sector is the rise of generative AI (artificial intelligence). AI demand is expected to grow 15 times from 2022 to 2027.

Consumption Recovery

India’s consumption sector has shown a mixed recovery post-Covid, with premium products doing well while mass consumption lagged. Urban consumption has outperformed rural so far, though rural spending is now showing signs of recovery. The rise in nuclear families, from 34% in 2008 to 50% in 2022, has fuelled discretionary spending and driven consumption growth. The shift from unorganised to organised retail is also a key growth driver. Rural consumption is poised to revive, supported by expanding organised retail, better infrastructure, rising household incomes, and government schemes.

Healthcare Spending on the Rise

Healthcare spending in India is set to rise with increasing per capita GDP (gross domestic product). The rising elderly demographics are leading to increasing medical spending. As a major producer of pharmaceuticals, vaccines, and medical devices, India is well-positioned to meet the global and domestic demand. With rising incomes and healthcare awareness, emerging markets like India are poised for rapid healthcare growth. India is also becoming a top outsourcing destination for contract development and manufacturing organisations (CDMOs), driven by cost advantages, favourable policies, and shifts in global supply chains. Additionally, the growing market for small molecule discovery and rising R&D investments present significant opportunities. 

Views are personal. The author is Nilesh Shah, MD, Kotak Mahindra Asset Management Company.