Edited excerpts from a chat:
What’s your reading of the current market mood? Are investors underestimating valuation and earnings risks or over-discounting optimism from GST, trade deals, etc?
So far this fiscal we have seen continuation of trends from the last few years. Domestic mutual fund SIP flows have remained largely resilient over last year against the backdrop of rather tepid aggregate earnings growth, elevated valuations and a market drawdown between Sep 2024 to Feb 2025. Some of the recent optimism about consumer durables and auto names is probably justified as the government has provided a sizable boost to consumption through tax cuts and monetary easing though in some sectors GST related optimism seems overdone. On the other hand, there is marked pessimism in sectors like IT due to negative news flow.
In a market where gold and silver are making more noise than equities, how should an investor think about asset allocation between equities, gold/silver and debt?
For most Indian investors, domestic equities should still be core allocation and more so if one has a longer horizon, as starting valuations become less important over longer periods. Tactically increasing allocation to debt looks like a good option at this point, given the elevated equity valuations. It is difficult to ascribe a fundamental value to precious metals and given both have delivered record returns over the last one year, I would prefer not to allocate more 8-10% to gold and silver now.
Which themes or sectors do you believe could deliver outsized returns over the next 5 years? Has GST 2.0 made you change your outlook on specific sectors?
Consumption is ~60% of the GDP. Given that mass consumption has struggled over the last few years partly due to lower wage growth and rising household debt, the monetary easing coupled with lower taxes should be a boost for mass consumption linked sectors at least over short to medium term. We estimate that through the income and GST tax cuts coupled with lower interest rates, the government has delivered a consumption stimulus of Rs 4.6 lakh crores or ~1.3% of the GDP which is significant. Among other sectors, we like healthcare services where rising penetration over the next 10-15 years, should be a positive for the likes of hospitals, diagnostics and health insurance. Companies in insurance, RTAs, depositories and wealth management offer attractive plays on the structural trend of financialization of household assets, which is underway. Our investment approach remains sector agnostic though.
What’s your advice to investors sitting on cash and waiting for a correction — patience or participation?
Investors should look for asset class diversification if they have lower risk tolerance or if they are close to their financial goals. For investors with longer horizons, participation in equity even under elevated valuations offers the best option to beat inflation. If someone has stayed invested over the last 5 years, then it’s a good time to rebalance and tilt the portfolio more towards defensive assets like debt.
Do you think mid- and small-cap valuations are stretched at this point, or is there still room for upside?
At this juncture, broad-based index exposure in small and midcaps calls for caution, and a more selective, bottom-up approach is warranted as valuations of in the small- and mid-cap indices, appear stretched both in absolute terms and relative to their historical averages. However, it is equally important not to generalize from aggregate valuations as in SMID space one can still find well run, profitable and high growth companies from a wide pool of over 700-800 stocks. Beyond the next 1-2 years, I think there is significant scope for significant returns in SMIDs if one takes a more selective, valuation aware approach focusing on company fundamentals, instead of broad themes.
Auto stocks have seen a sharp rally since the August 15 announcement on GST rate rationalization. How comfortable are you with valuations in auto stocks after that? Do you think we are at the start of a multi-year auto cycle?
Valuations in the sector have trended above historical averages after the recent rally and it seems the market is baking in a lot of optimism from GST rate cuts. Since most companies have chosen to pass on tax decrease to end customers, the valuation rerating probably reflects expectations of sustained higher demand, which is debatable as white-collar wage and employment growth remains patchy. However, there are well run companies within both two wheeler and four wheeler OEMs as well as within auto ancillary space which could justify these premium valuations in long run.
In the last few months, we have seen sustained supply of new paper via selling by insiders, promoters, PE/VC funds and now IPOs. Can we blame supply pressure as one of the reasons for the Indian market’s underperformance?
Yes, to some extent. Over the last four years we have seen domestic investors (MF+ BFI+ retail) increasing their stake in listed companies while FPIs and promoters (including PE owners) have been selling. Over the last one year we have seen close to $70 bn of equity supply compared broadly to inflows ~$55 bn into domestic MFs. Against this backdrop, secondary sales by FPIs combined with elevated valuations in Sept-2024 and slowing earnings growth, could explain some of the underperformance.
The market seems to be baking in chances of earnings recovery H2 onwards. Do you agree?
Yes, though I think H2 earnings recovery from the consumption stimulus could be partially offset by higher US tariffs, unless a trade deal is announced before. NIM’s of most banks would be under pressure this fiscal due to repo rate cuts. In my opinion, there is a higher chance of broad-based earnings growth recovery in FY27 across autos, banks, NBFCs, telecom sectors among others.
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