India's equity markets, economy: Will investors update their beliefs?

India’s stock market wears an air of resilience. Since the Covid-19 pandemic trough, the benchmark indices — the Nifty 50 and the Sensex — have repeatedly scaled new highs, buoyed up by domestic inflows, a swelling army of retail investors, and a compelling narrative of long-term growth. 

Yet, as the indices recently edged past their records, a curious disquiet set in. Many investors found their portfolios stubbornly in the red. Social media buzzed with perplexity. How could markets be at all-time highs while portfolios languished? There are vexing questions around the disconnect between Nifty returns and portfolio returns, between economic growth and earnings growth, and finally, between earnings growth and market returns, and the divergence between them. 

Nifty returns vs portfolio returns 

The Nifty is a club of giants — banks, financiers, software firms, pharmaceuticals, consumer staples, and commodity producers. These are mature, relatively stable businesses. They were never the principal beneficiaries of the recent investment frenzy. The great bull run of 2023 and 2024 was driven instead by small and mid-sized firms riding a wave of government capital expenditure (capex) — railways, roads, urban transport, defence, water, power, and green energy. Those companies soared, and retail portfolios rose with them. 

Since early last year, however, this massive government spending has slowed. It was blamed first on the general elections, and then on the monsoon. Later, geopolitical issues took centre stage — from United States (US) President Donald Trump’s tariffs to tensions with Pakistan — before the monsoon was blamed again. Hundreds of companies that had been flying high on government capex have since stagnated or fallen. These are the stocks that dominate retail portfolios. The Nifty, by contrast, barely noticed this and was unaffected. With the exception of Larsen & Toubro, few Nifty heavyweights are direct capex plays. Having risen less during the boom, they corrected less during the slowdown. Comparing the Nifty with a retail portfolio, then, is to mistake apples for oranges. 

Economy vs earnings 

 A second puzzle is the divergence between India’s nominal gross domestic product (GDP) growth and Nifty earnings. India’s GDP has expanded at a compound annual growth rate (CAGR) of about 10 per cent since 2008. The common belief is that Nifty companies should grow their sales and earnings faster than GDP because these firms are among the country’s largest, benefiting from economies of scale and market dominance. Yet, a recently released study by Motilal Oswal shows that Nifty earnings per share grew at a CAGR of just 8 per cent between 2008 and 2025. Why the disconnect? For starters, it was imported from the US, where around 70 per cent of GDP comes from consumption and most of that consumption flows into listed companies as sales. In India, consumption accounts for roughly 62 per cent of GDP, and a much smaller share flows into listed consumer companies. 

Capex further weakens the link. GDP is boosted by investment booms that barely touch Nifty firms. India has experienced this twice in the past two decades. The first was in the period before and after the global financial crisis in 2008. Under two Congress-led regimes, there was a capex boom, but hardly any Nifty companies benefited. Indeed, much of it involved large-scale plunder by crony capitalists and bankers. The second boom was government-led capex between 2022 and 2024, which directly benefited smaller companies but not Nifty constituents, as I have noted earlier. 

GDP growth and corporate earnings can diverge for other reasons as well. One is playing out in China, which has relied on ferocious competition to build immense manufacturing capacity. This has benefited the country but not its companies, many of which operate on wafer-thin margins. That is why China’s stock market scarcely reflects its impressive economic growth. Before China, other Asian economies — South Korea, Taiwan, and Japan — experienced periods of rapid growth in the latter half of the 20th century, yet earnings growth failed to keep pace. 

Earnings vs market returns 

The third belief is that higher growth in earnings will automatically translate into higher market returns. This is the most fallacious of the three because it assumes that starting and ending valuations do not matter, only earnings do. If starting valuations are low and exit valuations are high, returns will be strong, irrespective of modest earnings growth. At the depth of a bear market in October 2008, the Nifty stood at around 2,500. By early 2020, it had climbed to roughly 12,000 — an annualised return of 15-16 per cent, excluding dividends — despite earnings growth of just 7 per cent during that period. The reverse is equally true. Starting at high valuations and exiting at lower ones lead to wealth destruction. Taiwan recorded GDP growth of over 5 per cent a year between 1990 and 2008. Yet its stock market fell by almost 50 per cent over the same period, undone by valuation compression. Japan’s Nikkei delivered negative returns for 34 years from the 1989 peak. 

The past three decades have been punctuated by recurring enthusiasm about structural change, new missions, policies, and grand projects. For all the exuberance surrounding India’s stock market and economy, the ultimate outcome for investors has been rather pedestrian. The chief culprit is poor earnings growth — a variable that no amount of storytelling can obscure. Corporate profits, once expected to sprint on the back of reforms, consolidation, and formalisation, have instead only trudged ahead. That leaves only one other lever to boost returns: Low valuations. Yet even the bulls concede that valuations are not low today. The math is unforgiving. Without stronger profits or cheaper prices, storytelling fails. Will investors update their beliefs?

 

The author is editor of www.moneylife.in and a trustee of the Moneylife Foundation; @Moneylifers