The recent run-up in Indian equities has made the market more expensive but experts are not sounding the alarm yet.

Hopes of an end to the rate tightening cycle by the US, falling US yields, a weakened dollar index and a thumping win for the BJP in the recent Assembly elections has taken the market to record highs.

Indian equities are trading at over 20x the estimated FY24 earnings. The MSCI India index is trading at a premium (26.6x) to the MSCI EM Index (13.3x) and is above its historical average. India’s market capitalization-to-GDP ratio, which had moderated to 95 per cent in FY23, is now at 115 per cent (based on FY24 GDP estimates), and above its long-term average of 82 per cent.

“The market is looking a bit overbought,” said Andrew Holland, CEO of Avendus Capital Public Markets Alternate Strategies. “A correction may be in the offing, although not a large one.”

“There’s some disconnect between the current rally and ground reality,” said UR Bhat, director, Alphaniti Fintech. “The State election results and buying from overseas investors provided the trigger for markets to climb to fresh highs. That news has already been digested and liquidity accommodation is being withdrawn gradually.”

Bhat believes that valuations are at the top end of the range, with earnings growth expectations being somewhat soft.

Most consumption, investment and outsourcing-linked stocks are trading at ‘rich’ valuations, while financials continue to trade at attractive/reasonable valuations, said a recent note by Kotak Institutional Equities (KIE).

“We find very little value (as defined by a positive gap between fair value of the stock and price with sufficient margin of safety) in most parts of the market and continue to favour mega-caps and a few large-caps and quality mid-caps,” KIE’s managing director and co-head Sanjeev Prasad said in the note authored by two other analysts.

Not in bubble territory

Holland, who insists that the market isn’t quite in bubble territory, says that if overseas investors buy into this market, they will come to the large caps and the banking stocks, which have been laggards for the better part of this year.

Foreign portfolio investors have shopped for equities worth over $3 billion in December, taking their year to date purchases closer to $16 billion.

“Many large caps are reasonably valued and offer decent risk-adjusted returns. Select cohorts of small or mid-cap stocks could be overheated, though. Sector-wise, we see value in large banks, mass market consumer discretionary given a favourable base, and chemicals,” said Neelesh Surana, chief investment officer, Mirae Asset Investment Managers (India).

Bhat feels that there might be some valuation excesses in FMCG and construction stocks. Banks, which have done their bit to clean up their balance sheets, and automobile companies, which don’t seem to be suffering from any demand slowdown, may offer some value selectively.

According to Holland, the key risks for the market in the next few months will be all global: geopolitical conflicts, the interest rate trajectory in the US and commodity prices. “If there are sure-shot signs of an imminent fall in interest rates in the US that will act as a catalyst for Indian equities,” he said.

“I don’t see a big upside from here on unless the ruling dispensation returns with a bigger majority, geopolitical tensions abate, global demand revives and foreign investors continue to keep the faith in Indian equities. If these factors work out favourably, the market may rally another 4-7 per cent,” Bhat said.

Surana expects macros to stabilise, and growth to accelerate post-elections: “As the era of low-interest rates ends globally, investors will flock to regions with growth, and India is well-positioned to capitalise on that. Overall, investors with a 3-5 year timeframe, moderate return expectations, and purchases done in a staggered manner will not be disappointed.”

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