Markets stuck between rich valuation, tepid growth; SMIDs at risk: Report

Stock Market Outlook: The valuations of the Indian market and of most sectors and stocks are quite rich and well above fair values, cautioned Sanjeev Prasad of Kotak Institutional Equities

Market outlook: The consolidation in the Indian stock markets may continue for the next few months as rich valuations, weak domestic consumption and investment, along with global uncertainty cap any meaningful upside, believe analysts at Kotak Institutional Equities.

 

In a report titled 'Indian Markets: All dressed up and nowhere to go’', Sanjeev Prasad of Kotak IE pointed out that the stock market (primarily the benchmark indices) is ignoring risks from a sluggish domestic outlook and a challenged global macroenvironment underscored by a likely low growth and possibly high inflation.

 

 

"In this context, the valuations of the Indian market and of most sectors and stocks are quite rich and well above fair values. This suggests that investors, both institutional and retail, are yet to reconcile with the new reality," Prasad said in a co-authored report with Anindya Bhowmik and Sunita Baldawa.

 

On the bourses, the stock markets were highly volatile in trade today, swinging between gains and losses. The BSE Sensex index tumbled 1,199 points from the day’s high to hit a low of 80,575 level in the intraday trade.

 

The NSE Nifty50, on the other hand, crashed 343 points from the day’s high to hit a low of 24,502.

 

The market has been moving sideways since May 12, 2025.

 

Stock market outlook: Key risks

According to analysts at Kotak Institutional Equities, there is a disconnect between the valuations of the Indian stock markets and the fundamentals of the domestic and global economic growth.

 

On the domestic front, Prasad anticipates a slowdown in the Indian economy on the back of lower growth in investment, which would overshadow any potential recovery in consumption. 

 

"While there could be a gradual recovery in the domestic consumption demand, any major upside to demand recovery is ruled out due to muted growth in income of low-income and middle-income households and a possible slowdown in consumption demand of high-income households," it said.

 

Additionally, the brokerage projects moderation in central government capex, coupled with a modest pickup in state capex, despite a significant increase in state budgets for FY2026, likely slowdown in residential real estate demand, and no meaningful pickup in private capex, to curtail demand growth.

 

Globally, Kotak analysts said the flip-flop policies of the US administration on the tariff issue have created a great deal of uncertainties with respect to global growth and inflation.

 

While the markets, global and Indian, have already priced in the best-case scenario of the US and its major trade partners concluding trade agreements before the July 9 deadline, leading to moderate import tariffs and subsequent uptick in inflation, the reality is that only one trade deal (with the UK) has been signed for far.

 

"In a realistic scenario of dragged-out trade negotiations, the market could be volatile based on news (good, bad or ugly) but struggle to break out of a certain range," it said.

 

Stock market valuations

In this backdrop, the brokerage believes valuations of the Indian stock market have stayed at high levels in several sectors and stocks despite meaningful earnings downgrades.

 

This, it said, highlights a scenario where either the market does not care about valuations and/or the market does not care about earnings.

 

"In our view, this nonchalant attitude perhaps reflects the market's confidence in retail investors sustaining their hitherto price-agnostic purchase of stocks through mutual funds, and FPIs staying positive on Indian equities based on a ‘narrative’ of a lack of alternatives in emerging markets," it said.

 

Data, however, points out that retail investors have been reducing new investments into mutual funds. FPIs, on the other hand, are "value-sensitive" investors. As the Indian market has not performed in the recent global rally, investors should acknowledge that "Indian exceptionalism" may not be enough.

 

Largecap vs mid, smallcaps: Where to invest?

Kotak Institutional Equities believes the large-cap indices may find some support from continued optimism among investors about India’s long-term growth prospects and lower interest rates, but the small and mid-cap stocks (SMID stocks) have a long way to correct to their fair values.

 

According to the brokerage most large-cap and mid-cap consumption stocks (FMCG and durables), capital goods and EMS stocks, and outsourcing stocks (information technology) are trading at expensive valuations.

 

On the contrary, bank and non-bank finance companies (NBFC) stocks are trading at fair valuations.