India's valuation premium justified, can sustain if not expand: Rahul Singh

Equity market returns in the near term will be driven by earnings growth, considering there is limited scope for valuation rerating, says RAHUL SINGH, chief investment officer-equities, Tata Mutual Fund. In a telephonic interaction with Abhishek Kumar, Singh mentions that the only headwind for the market could emerge on the rural demand front. Edited excerpts:

How do you perceive the current positioning of the Indian market? Do you envision possibilities for further upside, considering valuations have run up?
 

The market reflects a sound economic environment, with valuations at a premium compared to other emerging markets, and justifiably so. We are in a better position in terms of economic outlook and overall macroeconomic stability. Rather than concentrating solely on the market, we should scrutinise the economy for any potential risks to the 7 per cent growth rate narrative. Currently, we do not foresee any major challenges, barring potential escalations in geopolitical tensions.

Several factors align for this valuation premium to sustain, if not expand. In such a scenario, equity market returns are expected to closely mirror the earnings growth rate, projected to be between 12 per cent and 15 per cent in 2024-25. 

What potential risks do you foresee?

Beyond the challenging-to-predict geopolitical risks, the primary headwind currently is the sluggish recovery in rural consumption. It remains uncertain whether this could evolve into a bigger setback, significantly impacting the gross domestic product growth rate at this point. A slowdown in demand also has the potential to impede the capital expenditure cycle, which is gaining momentum on the private side. However, this challenge may be offset by the increasing export potential.

Additionally, there are geopolitical tailwinds in the manufacturing space, with companies exploring opportunities to establish capacity outside of China.

Do you see businesses benefiting from the expected cuts in interest rates?
 

The heightened interest rates over the past year and a half haven’t adversely affected companies’ performances. Most of the interest rate-sensitive sectors, such as real estate and automotive, are thriving. If the increased rates haven’t negatively impacted demand, a potential decline in rates shouldn’t have a significant effect either.

Where do you anticipate returns coming from in the near term?

The valuations of private sector banks appear reasonable, with an attractive risk/reward profile from a one-year perspective. Another sector showing promise is pharmaceutical, with indications that the worst may be behind us. The pricing pressure, particularly in the US, has now alleviated.

In a period when numerous smallcap schemes have increased their exposure to largecaps, your smallcap scheme has no allocation to largecaps. What is the rationale behind this decision?

We aim to remain true-to-label. Despite having the flexibility to invest in largecaps, we have consistently adhered to this strategy. The scheme has completed five years. In July of the previous year, we imposed restrictions on lump sum investments to address deployment challenges, predating the discussions around smallcap liquidity issues.

We have observed a moderation in smallcap fund inflows in recent months. Simultaneously, investor interest is increasing in largecap and flexicap funds. Do you believe investors are making the right decisions?
 

I believe so. The risk/reward ratio in the largecap space is more favourable compared to smallcaps and midcaps. However, it’s essential to note that we are not pessimistic about smallcaps, considering the positive trajectory of the economy and the favourable trends in manufacturing and investment cycles.
 

What is your assessment of the third-quarter results that have been reported thus far?
 

The results were satisfactory. While the top line growth was not great, the profit growth reached the mid-20s. Much of this can be attributed to margin expansion, and it remains to be seen whether this trend can be sustained. Looking ahead, our forecast for the next year expects a growth rate of 14–15 per cent.