Reward-risk equation for Indian equities remains unfavourable despite recent fall: Kotak

Indian markets are currently navigating rough terrain as a conflux of global and domestic factors makes investors cautious about market direction, prompting them to exit risky assets. Markets have been on a downward trajectory since October, driven by concerns over expensive valuations, weak earnings, sharp FPI selling, and a slowdown in urban India.

Investors were hoping for a market rebound in the new year, expecting a revival in corporate earnings and improvements in geopolitical tensions. However, those expectations turned bleak after brokerage firms' projections indicated that Q3FY25 numbers could be another period of moderate performance.

Adding to the concerns, U.S. job growth unexpectedly accelerated in December, and the unemployment rate fell to 4.1%. This prompted traders to heavily scale back bets on Federal Reserve rate cuts this year, driving the U.S. dollar to its highest level since November 2022, crossing the 110 mark.

Markets are now no longer fully pricing in even one rate cut from the Fed in 2025, a sharp reversal from the roughly two quarter-point cuts projected at the start of the year.

Domestically, concerns over a slowdown in the Indian economy have deepened, as the downward revision of India's GDP growth estimate to 6.4% for FY25 has cast a shadow over the country's economic momentum.

Adding to investors' sour sentiment, crude oil prices touched a three-month high last week, while the Indian rupee extended its decline to over 86.6 per USD in the previous trading session, marking its lowest level on record.

Small and mid-caps bear the brunt in recent crash

Amid these concerns, both the Nifty 50 and Sensex have crashed nearly 1.50%, with small and mid-cap indices experiencing even sharper declines in Monday's crash.

The Nifty Midcap 100 index and Nifty Smallcap 100 index have skidded nearly 4% each. Yesterday's panic selling has sent both indices tumbling down up to 13% from their respective all-time highs, which were attained in mid-December.

Similarly, the Nifty 50 and Sensex are down by as much as 12.2% from their respective September peaks.

Despite the steep fall in the front-line indices, domestic brokerage firm Kotak Institutional Equities maintained a cautious outlook on the market, citing that valuations in most parts of the market still appear expensive.

Too early to get in, no real value in the market

"We continue to find the reward-risk balance for the Indian market quite poor despite the recent correction in the market. The recent sharp correction in the Indian market and stocks across caps does not change our cautious outlook for the market, given full to frothy valuations in most parts of the market, low scope for earnings upgrades, given fairly aggressive earnings, profitability, and volume assumptions across sectors, uncertain global macro-environment, and likely higher-for-longer bond yields and interest rates," said Kotak.

According to the brokerage, the rich valuations of most parts of the market simply reflect the price-agnostic buying behaviour of non-institutional investors and ‘forced’ buying of domestic institutional investors for the past 2-3 years. The lack of fear and the focus on greed (of returns) among retail investors have pushed valuations to absurd levels in several cases.

The brokerage noted that investors were willing to give any multiple for stocks irrespective of the business models and fundamentals, use exotic valuation methodologies and multiples, and believe any random narrative about sectors and stocks.

It is possible that retail investors may show some of their usual chutzpah and buy stocks aggressively (buy on dips has been the common mantra so far), but that would be really comical, it stated.

Correction in small-cap stocks will continue

"In our view, large-cap. stocks may hold up better in the next few months while mid-cap., small-cap, and ‘narrative’ stocks will see further severe correction if the alignment to fundamentals and value were to continue. There is no reason to expect otherwise," said the brokerage.

The brokerage further highlighted that FPIs are unlikely to view India favourably in the near term, citing no new money flowing into emerging markets, continued redemptions, and high valuations. Meanwhile, retail investors may increasingly grapple with dwindling trailing returns.

Disclaimer: The views and recommendations given in this article are those of individual analysts. These do not represent the views of Mint. We advise investors to check with certified experts before taking any investment decisions.