Aditya Birla Sun Life Mutual Fund: Annual Market Outlook 2025

Wishing you a Happy and Prosperous New Year 2025!!

CY2024 marked the 9th consecutive year with positive returns for the Indian equity markets. From a bird's-eye view, most global markets across asset classes gave robust returns outperforming NIFTY, with Bitcoin more than doubling, the U.S. beating growth estimates, and Gold continuing its rally upwards on the back of geopolitical conflicts. What set CY24 apart for India, was the construct of its equity market returns. Unlike CY23, which had large sectoral divergence with a few sectors (e.g. Realty, Capital Goods, PSUs, etc) giving outsized returns, CY24 saw a balanced return distribution with most sectors delivering around the mean returns. Post the Lok Sabha election results in June 2024, the market's character also changed, with the market breadth starting to weaken and a change in sector leadership, with previously laggard sectors such as Banks, Consumer Discretionary and IT, outperforming.

2025 is poised to be one of macroeconomic turbulence as the two largest economies— the U.S. and China— face significant policy shifts setting the stage for trade tensions and increased uncertainty. In the U.S., Trump's return promises a range of fiscal measures including more tax cuts, stricter immigration policies, and tariffs on imports. While these policies are expansionary and inflationary, they seem to run counter to the current macroeconomic backdrop, characterized by rising bond yields, an appreciating dollar, and concerns over fiscal deficits. With US inflation projected to settle at around 2.5%, the Federal Reserve is expected to cut rates by only 100 basis points, leading to a peak in bond yields and the dollar in early 2025.

With dollar at its strongest in real effective terms since the Plaza Accord of 1985, and China's strong reliance on exports, CY2025 is set for major forex wars, which will have an impact on both the Indian currency and trade activities. INR has been relatively less vulnerable to Trump trade and has outperformed against most currencies since October 2024. This has been on the back of comfortable forex reserves and aggressive RBI interventions. This has made INR significantly overvalued, and in the wake of surging USD, weakening pressure on CNY, the path of least resistance for INR is towards more depreciation. We expect INR to depreciate towards 88 in 2025, unless we see major reversal in dollar strength.

In India, after three years of 8%+ growth (FY21-FY24), GDP growth is expected to revert to a trend level of 6.5% in FY26 and 6.25% in FY25. The decline in growth during the first half of FY25 was primarily due to an extraordinarily sharp fiscal contraction (fiscal impulse at -2% of GDP), which should normalize in the second half of the fiscal year. Both fiscal and monetary policy are anticipated to ease in 2025 relative to 2024 levels. Growth appears to have bottomed out in the September quarter at 5.4% and is expected to incrementally rise from the third quarter of FY25 onwards towards the trend level.

In 2025, we foresee a balanced recovery with moderate upticks in both consumption and private investments. Private final consumption is likely to see some improvement due to a good monsoon and large income transfer schemes from state governments. The focus remains on consumption and private capital expenditure, which are expected to drive the country's growth trajectory. However, India's fiscal space remains limited, placing the onus on monetary policy to navigate this cyclical downturn. Inflation is projected to moderate to 4.5%, supported by lower food prices which have peaked. The 10-year Indian sovereign bond yield is expected to decline towards the 6.25%-6.50% range.

For Equities, 2025 is not going to be any easier than 2024 to navigate. With the Trump trade setting the stage in early 2025 and in an environment where India is not stimulating fiscally and monetarily, whereas U.S. and China are stimulating their economies, first few months are likely to be volatile. Over the past four years (2020-24), India's corporate earnings have significantly outpaced revenue growth, driven by shifts from unorganized to organized sectors, balance sheet deleveraging, and margin improvement. Looking ahead, as these gains normalise, profit growth is expected to align more closely with revenue growth, with corporate earnings projected to grow in the low teens over the next two years, particularly among BSE100 companies.

Since the Covid-19 pandemic, Retail investors, along with Domestic Institutional Investors (DIIs), have been driving market movements. From 2021-24, net FII flows amounted to only USD 6bn, while DII and retail investors collectively injected USD180bn. SIPs have evolved into a structural route of investment for the average Indian. Over the last 20 instances of market corrections >10%, SIP flows have sustained above their trailing twelve-month average 17 times. This indicates a fundamental change in the investment behavior of domestic investors.

Large-cap valuations remain reasonable, with the Nifty-50 trading at just a 5% premium to long-term historical averages on a 1-year forward PE basis. The market-cap share of large-cap stocks is at a 20-year low of 63%, while their profit pool share has increased to 68%. With 3-year earnings growths converging for small, mid, and large caps, we see better risk-reward potential for large caps in comparison. We believe CY25 will be a year to get "back to basics," prioritizing stability over reckless growth. Therefore, stock selection will be crucial for alpha generation. The key to success will lie in selective investing, focusing on companies with steady earnings growth, strong cash flows and prudent capital allocation.

From a sector perspective, we anticipate that previously underperforming sectors such as Private Banks, IT, Cement, Consumer Discretionary, FMCG, Metals, and Energy proxies could start to see outperformance moving forward. Additionally, a key theme to watch is the private capital expenditure led by conglomerates. With capacity utilizations at above-average levels and balance sheets largely deleveraged, there is substantial potential for private capex to drive the next phase of growth.

Looking ahead, asset allocation strategies are expected to yield steady results, diversifying across different asset classes. 2025 would be another good year for fixed income as we expect it to deliver returns in the range of 8-9%. Actively managed duration funds will do well within fixed income space. Precious metals, like gold and silver are expected to generate returns between 8-12% as investors look to diversify amidst global uncertainty. Equities would see a moderation in returns to 8-12%, aligning with earnings growth in a year of consolidation. Within equities we would recommend more allocation to large cap biased funds including flexi cap funds. Thus, we see a convergence of returns across asset class and this balanced outlook suggests a diversified approach to portfolio allocation, with each asset class offering potential for reasonable returns, but with varying degrees of risk. Therefore, multi-asset allocation funds are recommended for investors to navigate the expected market volatility.

Overall, the global and Indian macroeconomic environment presents a mix of risks and opportunities. India's growth story remains intact. While global uncertainty looms large, India's growth trajectory and structural story offer a solid foundation for those who approach the market with discipline and foresight.

The 2025 mantra is, "moderation, return to fundamentals, stability over speculative growth, balanced approach to navigate market volatility and capitalize on selective opportunities."

Source: ABSLAMC Research

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