Disappointment in Lok Sabha poll outcome will be short-lived: Pradeep Gupta

The Indian markets appear to be expensive, on an absolute basis, with 1-year forward valuation at 20 times. The overall risk/reward ratio, thus, seem unfavourable on a historical basis, Gupta said

The next big trigger for the Indian equity markets are the Lok Sabha election results. Due on June 4, PRADEEP GUPTA, executive director and head of investments (India) at Lighthouse Canton, believes markets are hoping for policy stability and continuity post the outcome. In an email interview, Gupta tells Tanmay Tiwary how the markets view general elections, and shares his perspectives on the current state of the Indian markets and potential risks. Edited excerpts:

How does the market look to you at current levels?

The Indian markets appear to be expensive, on an absolute basis, with 1-year forward valuation at 20 times. The overall risk/reward ratio, thus, seem unfavourable on a historical basis. Besides, the Indian markets are currently trading at around 85 per cent premium over emerging markets (EM) valuations, which is also above historical average.

Do you think the markets are disconnected from the prolonged higher-for-longer narrative playing out?

Rather than the disconnect, it's the India story, at large, that is playing out at the back of a macroeconomic cushion. However, what may not be factored in, at current levels, is incremental distortions on account of geo-political concerns. We haven't witnessed the kind of escalation that was envisaged in the Middle East.

India VIX, at large, has remained complacent. Markets, thus, will be quick to respond should there be a negative surprise.

Do you see any corrections ahead of the Lok Sabha election outcome? How should short-term investors approach the markets?

Lok Sabha elections have been inconsequential for the broader markets, after the initial euphoria. India has enjoyed political stability for the last decade, and markets at no juncture wish to have any other outcome. Any disappointment against consensus is likely to be short-lived as we have seen historically.

As a strategy, we have been building a safety net via market neutral strategies that eventually thrive on increased volatility and increased allocation to quality names that act as proxy cash. Tactical hedge, wherever necessary, has also been advised for the downside cushion.

Mid- and small-caps have recovered quite well after Sebi's Stress Test. Is the worst over?

Sebi's Stress Test had more of a sentimental impact than anything else. The regulatory intervention was well-timed and needed. The resultant correction has brought the valuations of mid- and small-caps to a reasonable level, hovering around the 5-year average.

It is the margin of safety and earnings predictability that is of more significance than the broader noise. Valuations at this juncture offer little comfort thus offering limited scope for re-rating. Therefore, earnings will have to do the bulk of the work in that case. The road ahead may not be one sided. But, any meaningful correction will likely be well lapped onto.

What's the road ahead for FII flows into Indian equity markets over the next one year?

We believe overall flows will follow earnings and macroeconomic stability while a stable mandate for the incumbent government in the general elections will also be a key monitorable. That said, a secular recovery in China could be of concern due to valuation cushion and broader recovery play.

On the other hand, with the kind of force DIIs have gone on to become, the FPI flows, at large, will continue to become inconsequential for Indian markets with their ownership hovering at the lowest levels in the last decade.

Has the Mauritius tax treaty set a cat amongst the pigeons?

Since 2017, various tweaks have been attempted in the Double Taxation Avoidance Agreement (DTAA) between India and Mauritius. The latest step seems to be aligned in the same direction.

This has been a trend globally and, hence, we do not see any long-term impact on FPI inflows into the country purely for this reason.

DMs vs EMs, where are investors tilting?

EMs have started outperforming developed markets over the past few months after enduring significant underperformances over the last couple of years. Among EMs, India remains a bright spot while China has emerged as one of the best performing equity markets for the past 3 months.

The latest World Bank report estimates DM economies to grow at 1.7 per cent in CY24, while EMs are projected to grow at 4.2 per cent. While there are potential headwinds, we feel EMs may outperform or remain steady in comparison to DMs over the next year.

And what about debt vs equity?

We may witness a continuation of the current hawkish monetary policy stance in major economies globally which, combined with restrictive liquidity measures, may keep returns from debt investments in abeyance for now.