Sensex gave positive returns for the 7th straight year in 2022. Will this trend continue in 2023? Ambit answers

2022 marks the seventh consecutive year of Sensex’s positive returns in rupee terms. The benchmark rose around 6 percent in the previous calendar year. The last time Sensex gave negative returns for a year was in 2015. This has happened only thrice since 1985 and has been the longest-ever stretch of positive returns, outpacing the six-year record streak witnessed from 2002 to 2007.

The Indian indices have also been outperforming global peers. 2021 was a stellar year for Indian equities with the Sensex rallying over 20 percent and outperforming FTSE EM by 22 percent in dollar returns. The outperformance continued in 2022 (14 percent). But will Indian indices break this trend in 2023? Ambit Answers.

According to the brokerage, though there isn't any relation between returns of two consecutive years, it sees some risk emerging with SIP flows tapering and some moderation of FII inflows in Indian equities with China’s reopening in the near term.

However, it pointed out that India’s resilient earnings trajectory and contraction of the Availability factor remain supportive of the outperformance of Indian Equities.

Yes, valuations are relatively expensive, warned Ambit, but it added that putting it all together, it expects outperformance to last but to reduce from 14 percent in 2022.

It further noted that its regression analysis based on Sensex annual returns starting in 1986 suggests that Sensex annual returns have little bearing on Sensex annual returns next year. There is no linear relationship! The returns are a function of entry multiples, discount rates, earnings upgrades, etc. and each of these factors can influence the returns, it noted.

Nonetheless, the brokerage informed that since 1985, there have been only 3 instances when Sensex has delivered positive returns for a period of 6 or more consecutive years- 1988 to 1994 (7 years), 2002 to 2007 (6 years), and 2016 to 2022 (7 years) on a calendar year basis.

However, the brokerage explained that while the earnings sustenance does explain the outperformance, the robust DII flows particularly over the first half of 2022 have also cushioned Indian equities from volatility. But, these flows have become muted over the last few months, it cautioned.

Despite FIIs pulling out $17.1 billion from Indian equities, markets remained resilient as DIIs pumped $35.8 billion in CY22. This was led by stable SIP inflows from retail investors, which has tapered recently as evident in net SIP inflows, pointed out the brokerage.

However, this was moderated in the second half of 2022. In the first half, DIIs put in $30.4 billion while in H2CY22, this figure was reduced to $5.4 billion.

Why did this happen? "DII flows face a double whammy of rising bank deposit rates and moderation in Nifty 1-yr returns. For Nifty to show positive annual returns, it has to sustain above 18,300. The base of the 12-month rolling return has shifted higher! The market returns have fallen and are in negative territory. Historically, this has coincided with a reduction in DII net equity inflows," explained Ambit.

However, a key positive is that the worst of FII outflows are behind us, stated Ambit.

It highlighted that the psychological factor appears supportive with FII outflows possibly coming to end, a factor that controls the Nifty direction. Over 2000-22, FII outflows have always occurred in anticipation of rate hikes but have been positive over the next 12 months in rate hike cycles, it mentioned.

Lastly, it also informed that historically, over the last 2 decades, the worst 20 monthly episodes of FII outflows have often signaled the end of 'FII selling' and the market has closed up 18/20 times higher. That period is now over and hence the brokerage expects this trend to continue.

However, it also pointed out that "while the inflows are likely to continue, with China opening up, EMs’ economic activity would spur up and would benefit the EM basket. This can lead to FII inflows scattering across other EMs along with India, though the earnings trajectory of India remains robust. But, a fillip towards other EMs with China opening is likely and some normalization in FII flows is possible!"

It also noted that “Long China” trade may or may not materialize but FII inflows in India are not negatively correlated with inflows in China. The inflows in China in 1 month are significantly higher than annual inflows in India, long China trade wouldn’t necessarily be funded by outflows from India (moderation in inflows is also possible) considering FII ownership of Indian Equities is still one of the lowest over the decade and India still offers the best growth amongst major economies, it warned. So, in a nutshell, some moderation of FII inflows is possible but it expects outperformance to last but to reduce 2022.

All in all, the brokerage believes that while the near-term is not very favourable for Indian markets, its medium-term perspective remains robust.

While factors like moderation in DIIs as well as near-term FII selling are key headwinds, it is likely to turn favourable in the medium term.

Also, the brokerage highlighted that India's economic recovery has been resilient, the inflation trajectory albeit higher is still not as steep as it is in developed markets, and government policies such as production-linked incentive schemes have lifted business sentiment and strong FDI flows, which are also tailwinds.