Expert view: Sahil Shah, Managing Director (MD) and Chief Investment Officer (CIO), Equirus, believes one or two quarters of earnings misses or external events could disrupt the Indian stock market in the short term. However, corporate earnings in the broader market can double over the next four to five years, with small-cap earnings expected to grow even faster. In an interview with Mint, Shah shared his views on the impact of the US election on the Indian stock market and emerging investment themes.
A consistent narrative around expensive valuations has emerged between the last Samvat and the current one.
However, during this period, Nifty 100 has surged by 32 per cent, with midcaps and small-caps rising over 40 per cent, microcaps climbing 50 per cent, and the SME IPO index skyrocketing by 138 per cent.
Despite this impressive trajectory, we've witnessed minor corrections of 5-10 per cent in the small-cap index, indicative of the market's inherent volatility.
Recently, increased fluctuations have been observed, largely due to shifts in allocation and foreign institutional investor (FII) selling.
Specific sectors, like defence, have also experienced corrections after substantial valuation run-ups. Looking ahead, quarterly earnings and market sentiment will play pivotal roles in determining market movements, which remain difficult to predict.
The unexpected Chinese stimulus, for example, has led to shifts in global allocation, contributing to recent volatility in Indian markets.
We believe this turbulence is temporary. India's fundamentals remain robust compared to many larger economies.
While one or two quarters of earnings miss or external events could disrupt the market in the short term, we are confident that corporate earnings in the broader market can double over the next 4-5 years, with small-cap earnings expected to grow even faster.
Based on the trailing earnings, small midcaps are trading at 32x P/E. Given that this is the average P/E of all companies in the index, there are opportunities available at reasonable valuations, which, over time, have been reduced as markets and valuations have been going up.
In large-cap indices, while financial services carry significant weight, which is at or below historical valuations, capital goods and consumer discretionary have large weightage in small-cap indices, where companies are trading at very high multiples on a trailing basis.
This majorly explains why large caps trade at lower multiples to small caps under the current scenario. When we look at the growth rates of capital goods companies (esp. small caps) in aggregate, they have grown at 30 percent+ in Q1FY25, far ahead of small-cap companies' aggregate growth.
The fiscal year 2024 witnessed remarkable earnings growth among NSE 500 companies, accompanied by moderate revenue growth.
However, in Q1 FY25, the gap between earnings growth and revenue growth has narrowed considerably. This trend raises important questions as we assess the sustainability of earnings in light of broader economic indicators.
High-frequency data points, such as GST collections, automobile sales, and cement demand, suggest a deceleration in growth, but we anticipate gaining clearer insights as Q2 FY25 figures are released.
While certain sectors may still represent reasonable valuations, the overall market increasingly reflects an optimistic outlook, particularly in pockets where valuations have escalated. This optimism carries the risk that any earnings misses could lead to market volatility.
India's corporate balance sheets are currently in their strongest position in years, paralleling the robust health of the banking sector.
Furthermore, our external balances are well-managed, supported by strong reserves, and the fiscal deficit remains firmly under control.
Given this favourable backdrop, it seems unlikely that we will experience a significant market correction, barring unforeseen geopolitical events or a hard landing in the US economy.
However, we should remain aware that smaller corrections cannot be entirely dismissed.
Historically, over the past 20 years, small-cap and mid-cap indices have experienced intra-year corrections of at least 10% from their calendar year highs, even during the most robust bull markets. It's important to note that these corrections often occur from peaks that are only clear in hindsight.
On the flip side, it's worth highlighting that three out of four years during this two-decade span have delivered positive returns, with an average annual return exceeding 20 per cent.
This resilience illustrates the strong long-term growth potential in Indian equities, particularly within the small-cap and mid-cap segments.
As we navigate the current market landscape, it’s essential to remain vigilant and prepared for short-term fluctuations while keeping our focus on the underlying strength of corporate fundamentals.
Kamala Harris's approach is to increase taxes, focusing on systemic change and global cooperation, while Trump's ideology centres on tax cuts, nationalism, and a more isolationist foreign policy.
These differences reflect broader political and social divides in the US. Donald Trump's more isolationist policy did not impact India’s export-oriented sectors like IT services, chemicals, and healthcare during his tenure.
RBI maintained the policy rate at 6.5 per cent as expected but changed the stance to “neutral” from “withdrawal of accommodation.
The key driver for change in stance is the growth-inflation balance, which creates a congenial condition. In summary, with the US rate cut, fiscal consolidation, and India’s external position with robust reserves giving some room for accommodation, RBI probably feels it is too early to let the guard down.
A neutral watch rather than a hawkish watch gives more flexibility to act when the time is right.
In contrast, while the Federal Reserve appears to be taking actions based on forecasts, the RBI’s strategy seems firmly rooted in real-time data and economic realities.
This data-driven approach positions the RBI to navigate potential challenges effectively, ensuring it remains responsive to domestic and global economic shifts.
We believe emerging themes are too expensive, while traditional themes/sectors are better placed in terms of valuations.
In the new Samvat, it’s time to go to the“traditional” sectors. For example, IT services, lending financials and chemical stocks are three sectors we like at the current juncture as they have underperformed in the past two years, making valuations more palatable.
This has happened as they have gone through a rough patch. While the reasons were different, earnings growth and visibility of such growth over the medium term were challenging.
We are at the fag end of the challenging phase or, in some cases, have been out of that.
Hence, it appears to be at a perfect juncture where growth is not fully priced in, but positive earnings surprises are possible.
New-age tech firms have delivered far superior growth to their traditional counterparts, whether Policy Bazaar versus some insurance companies or Zomato versus QSR companies.
More importantly, most of the new-age tech firms listed when they were reporting losses but, in the last few quarters, have either reduced losses significantly or have started reporting profits.
Given that growth outperformance will continue, the JAM trinity will allow for more adoption and penetration, and the path to profitability will become more visible. Values are pricing in a significant profitability increase over the next 2-3 years.
The risk of volatility and returns are two sides of the same coin. Hence, short-term volatility can not be avoided to make returns substantially above inflation. Through smart allocation decisions, volatility can be reduced to an extent.
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Disclaimer: The views and recommendations above are those of individual analysts, experts, and brokerage firms, not Mint. We advise investors to consult certified experts before making any investment decisions.
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