India’s stock market valuations are considered rich after the near one-way move since Covid. What are your thoughts?
Valuations have moved up but they have to be viewed in the context of the overall growth environment. Large-cap share valuations are at a relatively modest 10-15% premium to their historical averages. On the other hand, mid-caps are trading at 35-40% premium and so identifying sensible opportunities is becoming quite challenging. While small-caps are also trading at a premium of 30%, the relative premium compared with mid-caps is less. In small-caps, we have seen a substantial improvement in the overall profile of the universe with better return on equity (ROEs), lower debt and higher disclosure standards. As the relative premium is less and the universe is considerably larger, the landscape in small-cap, while challenging, is somewhat better.
Are you seeing a shift in foreign money from expensive India to cheap China?
Chinese stocks are attractive and any sign of economic stability would encourage some flows back into China. However, I don’t think this will happen at the expense of India as there is enough capital sloshing around. India’s story remains attractive and can stand on its own feet. While foreign capital flows may vary in any given year, it is hard to ignore India from a long-term standpoint. Moreover, several developed markets are facing structural growth challenges and some money may get reallocated from these markets into select emerging markets on a longer-term basis.
What kind of returns should investors expect from domestic equities?
Considering the sharp rally in the Indian market and the consequent elevated valuations, we could see a period of elevated volatility and some moderation in returns. While the long-term outlook remains encouraging, it would appear to be prudent to shave off a few percentage points from near-term return expectations.
Where are the investment opportunities now?
The government’s thrust on infrastructure creation is well known and has led to a fillip to infrastructure and capital goods companies. The investment theme continues to be strong despite weak private capex which benefits a wide variety of businesses, including product companies, construction entities, and material providers.At the same time, the rising emphasis on self-sufficiency will benefit manufacturing industries including EMS, and auto ancillaries. Defence is another segment that is seeing strong traction. However, stocks have rallied sharply and hence investors must balance attractive prospects against challenging valuations.
Consumption has been a laggard as elevated inflation and erratic monsoons have adversely impacted rural spending. We are seeing incipient signs of improvement. This is an area that has been relatively neglected and merits a closer look.
Similarly, financial services is an interesting area. Valuations are quite sensible and if India is to continue to do well, financial services will play an integral role.
What is the big risk to market now?
Currently, with the market having rallied sharply, elevated valuations themselves pose a risk. Several large countries are undergoing elections and hence political uncertainty is magnified. Corporate profitability is at a multi-year high, and if raw material prices were to bounce back, it may put some pressure on corporate margins and put earnings at risk.