Pratik Gupta: Market valuation restricts upside in the short term

Are you altering your view on the market from what you held before the general-election results?

We believe the new coalition government implies broad continuity and stability in policy making and overall economic development. Any compromises may perhaps be on the political or social agenda, but less so on the economic agenda—although it may become tougher to push through controversial economic reforms like privatization or land/labour/farm reforms. We expect fiscal consolidation and focus on manufacturing, in particular, to continue. Our view ahead of the elections was that the market was somewhat expensive, with the Nifty trading at 21x FY25 P/E. The market is now back to the same level as pre-election results, so that view doesn’t change. We see limited upside in the short term, although our 3-year view remains positive.

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 What are the sectors you’re bullish on now and why?

We like the banks and non-banking financial companies (NBFCs) which are still reasonably valued compared to most other large sectors—the worst of the net interest margin (NIM) pressures are behind us, credit costs are under control and loan growth should accelerate. We also like the residential real estate, hotel, and hospital sectors where we believe the demand-supply gap will persist, government policies will remain supportive and there is potential for earnings upgrades. We believe the capital goods, defence and infrastructure plays also offer strong earnings growth prospects, but we find limited upside at current expensive valuations, which are pricing in all the good news. 

Do you think the fiscal deficit issue will crop up as the Bharatiya Janata Party (BJP) changes its stance on prudence given the state elections in Maharashtra and other compulsions? 

We expect the Union government to achieve a lower fiscal deficit of 5% in FY25. Even if there are some minor concessions made to accommodate coalition partners’ demands, and some shortfall from divestments, we believe there is adequate cushion from the larger-than-expected RBI’s surplus transfer of ₹2.1 trillion. In addition, with real economic growth of 7% this year and strong GST/direct tax collections, as well as the likelihood of a good monsoon and stable global oil prices, we don’t see the risk of a fiscal slippage.

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How will bond yields (inflation) and currency movement play out in the short to medium term? 

The US market is now expecting only one to two Federal Reserve rate cuts later this year, so we expect the Reserve Bank of India (RBI) to follow through as well in 2HFY25—especially as India’s inflation is on a downward trajectory and the government’s fiscal deficit is also coming down. We expect the repo rate to fall by 50 basis points (bps) to end FY25 at 6% and accordingly the 10-year bond yields also to soften a bit. The current account deficit will likely increase slightly to 1.1% in FY25, but we also expect strong passive inflows from global bond index funds to support the rupee and RBI intervention to manage the currency volatility, hence we expect the INR/USD to remain stable at around the 83-level in FY25. 

Indian stock valuations (one-year forward PE) are well above the long-term average. Does that worry you in the current environment?

India’s Nifty is trading at 21x FY25 P/E, which is one of the highest multiples in the last 20 years. It is also expensive versus other emerging markets India's premium to the MSCI EM Index is now ~70% versus the historical range of 20-90% and the earnings-bond yield gap is not attractive. However, this is supported by a very solid macro and corporate earnings growth outlook, with steady local inflows. Nonetheless, we're worried about expensive valuations in some "narrative" stocks in the defence, railways, and power sector where stocks are more than pricing in the best-case scenario. We find better value in large caps in general.

 What is your view on corporate earnings? Any change in forecast after the general-election results?

We expect the Nifty’s earnings (excluding one-offs) to grow at a 14% compound annual growth rate (CAGR) in FY25-26, and there is no change to this forecast after the election results. We expect relatively stronger growth in the capital goods, cement, hospitals, metals, NBFC, and telecom sectors. Weaker growth is expected from the autos, consumer staples, chemicals, and the oil & gas sectors. 

Do you think local investor flows into mutual fund (MF) will continue apace? 

Yes, we believe the (SIP) flows will continue given that equity as an asset still offers one of the best post-tax returns over long periods of time. The attractiveness vis-à-vis debt has further increased after the higher taxes on debt last year. Lumpsum flows tend to be relatively more volatile but given the strong growth outlook for the economy and for corporate earnings, we believe that will also continue. The main risk to such flows is that of any adverse changes in the capital gains tax structure for equities. 

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What is your overall advice to investors in the current environment? 

Equity is not a risk-free asset class and there will always be some volatility in the short term, hence investors should ideally invest only with a long-term horizon of at least three to five years. Volatility due to nervousness around the new government should not worry long-term investors. Equities' post-tax returns should beat fixed income returns in the long term so one should figure out the right asset allocation with the help of an advisor and stay invested in the market.