Market shifts towards high-growth stocks amid volatility, says PGIM India Mutual Fund

The fiscal year has been marked by significant market volatility, particularly after major events such as the union election results and the hawkish monetary policy changes by the Bank of Japan. According to PGIM India Mutual Fund, the Nifty 50 Index experienced sharp corrections, dropping more than 2 per cent on specific days due to these events. However, despite these initial dips, the market rebounded quickly, hitting new all-time highs. Beneath this recovery, investor preferences have shifted, with high-growth, high-quality companies regaining favour, observed PGIM in a recent report.

High-Growth Companies Reclaim Leadership

The report informed that historically, the market has rewarded companies with high sales growth and strong returns on equity (RoE). As of September 9, 2024, high-growth companies delivered median returns of 32 per cent CAGR over the last five years, compared to the NSE 500's 25 per cent. However, FY24 saw a reversal of this trend, with companies showing lower growth and RoE outperforming their high-growth peers by 35 per cent from April 2023 to May 2024. Following the June 2024 union election results, high-growth companies made a comeback, outperforming lower-growth firms by around 10 per cent, noted the report.

Drivers of the Market Shift

PGIM identified several factors driving this change. One key reason is the shift in interest rate expectations from global central banks, led by the US Federal Reserve and the European Central Bank. Indian interest rates have largely followed the Fed's moves, and rates are expected to decline over the next year, providing a supportive environment for high-growth companies.

Another factor contributing to this shift is earnings performance. Research from Ambit Capital indicated that Q1 FY25 was relatively weak, with the NSE 500 showing a negative earnings surprise of 4 per cent. Fewer companies exceeded earnings expectations, while more firms missed estimates, particularly in cyclical sectors, it added.

Impact of Interest Rates on High-Growth Companies

The MF further underscored that over the past three years, rising interest rates have significantly impacted high-growth companies, which typically have longer durations. With the US Fed funds rate climbing to 5.25 per cent and India's repo rate reaching 6.5 per cent, high-duration assets like these companies faced greater pressure. As interest rates begin to decline, the future cash flows of high-growth companies are discounted at lower rates, boosting their valuations. While bonds see this re-adjustment almost instantly, the equities process takes longer, over months or years, depending on how rates change.

PGIM Mutual Fund also pointed out that this valuation re-adjustment will continue as long as interest rates fall, providing a favourable tailwind for high-growth companies. However, once interest rate cuts level off, the pace of valuation re-adjustment will slow.

The market is undergoing a clear shift, with high-growth, high-quality companies once again in favor. This shift is largely driven by expectations of a more dovish interest rate environment, which benefits these firms. While earnings expectations remain strong for high-growth companies, cyclical sectors may face headwinds due to weaker earnings. As interest rates trend downward, high-growth strategies will likely continue to gain traction, supporting the valuation of these companies.

Disclaimer: The views and recommendations made above are those of individual analysts or broking companies, and not of Mint. We advise investors to check with certified experts before taking any investment decisions.