'Domestic flows will sustain, but will not rise meaningfully from here'

The pockets of the market in which excess exuberance can be seen will undergo a reality check of earnings and valuations, said Gautam Sinha Roy of ICICI Pru Life Insurance

The Sensex hit the 80,000-mark milestone in intraday deals on July 3. GAUTAM SINHA ROY, chief - equity funds at ICICI Prudential Life Insurance, tells Puneet Wadhwa in an email interview that going forward, earnings delivery, which remains strong, would be the key driver for stock returns with some moderation in valuations possible. Edited excerpts:

Would you call the market's recent spurt from June 4 low as irrational exuberance?

Short-term equity market movements are often driven by liquidity flows and sentiment changes. With the elections out of the way, the market has been reinvigorated, driven by domestic flows and the return of foreign institutional investors (FIIs). Also, the market sentiment seems to be acknowledging policy continuity for the next five years, which is supportive of investment led GDP growth.

The market attention will gradually shift to earnings and valuations. Market earnings are expected to rise in the ‘early teens’ for the next two fiscal years, versus over 20 percent per annum seen in the previous three years. Hence, we expect some tempering of market returns going forward. 

The pockets of the market in which excess exuberance can be seen will undergo a reality check of earnings and valuations. Some laggard sectors of the last couple of years are likely to outperform.

What are your / market's expectations from the budget?

The upcoming Budget in July will set the tone for the next five years’ policy direction. The government is expected to strike a balance between infra and welfare spending. We expect the taxation framework to remain consistent and not cause any significant disruption. While the real estate market has seen a revival in the last three years, the affordable housing sector, crucial for lower-income groups, has been a laggard and might see some policy support.

Your view on the mid-and small-caps?

The last three years (FY 2021-2024) have seen midcap earnings compounding at around 25 per cent CAGR. During this period, the midcap index has delivered somewhat better returns and now stands rerated to 30x its one-year forward earnings, which is relatively high as compared to the long-term average. The small cap index, too, follows a similar trend. 

Though the favourable domestic investor sentiment largely remains intact, the high valuations are raising some concerns. Going forward, earnings delivery (which remains strong) would be the key driver for stock returns with some moderation in valuations possible. 

When will the foreign investors chase Indian stocks with 'animal spirits'? 

FIIs purchased $21.4 billion in CY23, whereas they sold $17 billion in CY22. In CY24, they had been net sellers till May but turned net buyers in June. As of March 2024, for the NSE-listed universe, the Foreign Portfolio Investment (FPI) ownership is down to the sub-18 per cent; lowest in the last 47 quarters. 

What about domestic flows?

While looking at the FII positioning, we need to look at India’s positioning vis-à-vis other emerging markets (EMs). MSCI India currently trades at a 72 per cent valuation premium to MSCI EM, making other EMs more attractive than India for the FIIs. However, FIIs will invest in India more vigorously when this valuation premium shrinks.

For Indian savers, there has been a shift in savings habits from other financial assets to equity financial assets. Among all asset classes, the household exposure to equity in March 2013 was 2.2 per cent; this has risen to 4.8 per cent as in March 2023. Considering the current macro/market scenario, domestic flows will sustain, but will not rise meaningfully from here.