In the first half of August, financial stocks on Dalal Street took a significant hit as Foreign Institutional Investors (FIIs) pulled out a staggering Rs 14,790 crore. This sudden withdrawal, coupled with a shift towards more defensive sectors like healthcare, FMCG, and consumer services, has raised concerns about the future trajectory of the financial sector in India. The question now arises: should investors go against the wind and see this as a buying opportunity, or should they follow the FIIs’ lead?
The FII Exodus and Its Impact
The withdrawal by FIIs from financial stocks was part of a broader sell-off in the market, where they turned net sellers to the tune of Rs 18,823 crore between August 1 and 15. This marked a sharp reversal from their position in the previous fortnight, where they were net buyers of Rs 11,646 crore.
The financial sector wasn’t the only one affected. FIIs also pulled back from metals, services, construction, and auto stocks. Conversely, they increased their exposure to healthcare (buying Rs 3,462 crore), consumer services (Rs 2,196 crore), FMCG (Rs 1,785 crore), and power (Rs 1,169 crore), sectors traditionally seen as safe havens during economic uncertainty.
Why Did FIIs Sell Financial Stocks?
FIIs typically have substantial holdings in IT and financial sectors, making them the first port of call whenever there’s a need to adjust exposure to the Indian market. While IT stocks saw only a minor sell-off, financials bore the brunt of the FII pullout.
The primary reasons for this bearish stance on financials can be traced back to the recent earnings season. The banking sector’s earnings fell short of expectations, with rising credit costs emerging as a significant concern.
Naveen Kulkarni, CIO of Axis Securities PMS, explained that FY24 was characterized by low credit costs, so any increase from that low base was expected. However, the actual rise in credit costs was steeper than anticipated, leading to a sector-wide de-rating.
Credit growth in the June quarter was also softer than usual, impacted by a sluggish deposit growth, an elevated loan-to-deposit ratio, and a deceleration in unsecured personal loans and NBFC segments. Credit growth moderated to 1.5% quarter-on-quarter (QoQ) in Q1FY25, down from 2% in Q1FY24 and 2.9% in Q1FY23, while deposit growth slowed to less than 1% QoQ.
Despite a reduction in the opex to assets ratio for most banks, core earnings have been under pressure, with single-digit year-on-year (YoY) growth expected for FY25. However, return on assets (RoA) for most banks remains healthy, surpassing long-term averages.
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Should Investors Go Against the Wind?
The recent sell-off has resulted in financial stocks trading at more reasonable valuations. The market appears to believe that the peak of the current asset cycle has passed and that return ratios for most banks are unlikely to improve significantly from here. However, some analysts believe this view might be too pessimistic.
Naveen Kulkarni suggests that the current valuations present a favorable risk-reward scenario, making financial stocks an attractive buy at these levels. JM Financial also recommends focusing on larger banks like ICICI Bank, Axis Bank, and SBI, which they see as top picks due to their stronger balance sheets and more resilient performance.
The Road Ahead
With the ongoing shift in the interest rate cycle, market sentiment is likely to gravitate towards sectors that offer low volatility and steady growth. However, Axis Securities advises investors to use market dips as an opportunity to invest in financial stocks, particularly those with strong balance sheets, as these are likely to offer significant upside potential.
In conclusion, while the FII exodus has certainly cast a shadow over financial stocks, the underlying fundamentals of many banks remain solid. For investors willing to take a contrarian approach, the current environment might offer a unique opportunity to buy into financial stocks at attractive valuations, potentially reaping rewards as the sector stabilizes and regains its footing.
