Budget Presents Opportunity For Targeted Buys 

Despite a staggering ₹60 trillion erosion in equity wealth from its 52-week highs, the Union Budget has largely sidestepped introducing positive measures for retail investors. Equity market capitalisation has surged fivefold from ₹84 trillion in 2014 to ₹424 trillion now, representing 131% of India’s nominal GDP for the 2024-2025 revised estimate.

The decision to hike long-term capital gains tax on foreign institutional investors appears rational, yet could trigger short-term headwinds for both equities and the rupee if foreign institutional investors accelerate their sell-off. Historically, such tax hikes are best implemented during bull market peaks, when the impact can be absorbed with minimal disruption.

India's foreign exchange reserves have dipped to $629.6 billion, while the rupee remains under pressure. However, India's foreign debt-to-GDP ratio stands at a modest 11.1%, providing a cushion against global volatility. The projected GDP growth of 6.5% for 2025-2026 and 2026-2027 remains among the fastest globally. This, coupled with fiscal discipline, could pave the way for a sovereign rating upgrade by 2025-2026, potentially reversing foreign capital outflows.

The budget has laid the groundwork for improved economic and market prospects in 2025-2026. Yet, the sharp corrections in the Sensex and Nifty50—down 11% and 12% from their respective peaks—have dragged their trailing 12-month price-to-earnings ratios below five- and ten-year averages. The Sensex trades at a trailing 12-month price-to-earnings of 22.2x versus historical averages of 25.4x (five-year) and 27.5x (ten-year), while the Nifty50 stands at 21.7x compared to 23.9x and 26.7x, respectively.

Small- and mid-cap stocks have borne the brunt of the correction, with declines ranging from 20% to 50% over the past four months. This presents selective opportunities, especially within small- and mid-cap segments, where valuations now appear attractive. Foreign institutional investors may persist in offloading large-cap holdings in the near term, but domestic retail participation remains robust, with over 800,000 new investors entering the market just last week.

In the short term, small- and mid-cap stocks are likely to outperform large caps due to their sharper corrections and M&A play potential . Domestic demand-driven companies and deep-value small- and mid-cap stocks present compelling investment opportunities for immediate allocations.

While fiscal prudence measures in the budget support long-term growth, equity markets may remain subdued until the end of 2024-2025, weighed down by foreign institutional investor tax concerns.This could present compelling entry points for  quality small- and mid-cap stocks in February and March 2025. As demand recovers, GDP growth accelerates, and the Reserve Bank of India potentially shifts towards rate cuts—supported by fiscal consolidation and declining deficits—both the economy and markets could see significant improvement in 2025-2026.

The optimistic outlook for 2025-2026 hinges on macro stability. Key risks include potential United States trade restrictions on Indian goods and Information Technology services, along with a sharp surge in global crude oil prices. These factors could dampen the positive trajectory anticipated for India’s markets in the coming fiscal year.