Indian equities are trading at a premium to their long-term averages which makes them unattractive from a near-term perspective. We feel that equity markets should see some correction in the coming quarters. A revival in domestic consumption across its various heads could be a key positive going forward. However, disappointment in government spending on capex could be a drag.

Markets are overvalued across various market cap buckets. Having said this, the extent of overvaluation is lower in large caps versus mid and small caps. So, from a relative perspective, there is definitely more comfort in large caps.

Some of this could be attributed to flows moving into China ever since the Chinese government announced a slew of steps to revive their economy. This may have triggered a slight shift in allocation towards the Chinese markets, which have been trading at cheap valuations anyway. Q2 results for the Indian corporates have also been disappointing reflecting the slowdown in economic activity. There has been a markdown in earnings growth across the board and this may have also contributed to the selloff.

RBI will try to gain comfort on the Fed’s trajectory of rate cuts. If it is reasonably clear that the Fed will cut around 125-150 bps in 2025, it would give RBI enough space to start cutting the repo rate. The last thing that RBI may want is to have pressure on the rupee on account of unattractive rates. Secondly, inflation in India has also been playing spoilsport over the last few months. This is another vector that RBI would want to watch before pulling the trigger.

Returns given by equity markets over the last few years stand out vis a vis other asset classes. Investors have been emboldened by these returns and there is a feeling of missing out in general. This has led to an ever-increasing SIP flow over the last one year, which we feel should continue. That said, flows could get impacted temporarily if markets turn sideways for a few quarters or give negative returns.

Small caps as well as sectoral/thematic funds have seen one of the highest flows across MF categories, which is a concern. It is common investor behaviour to get excited about a particular theme when it has already done very well and may be at its peak. Likewise, investors have been attracted to the superlative returns shown by small-cap funds over the last few years and making high allocations towards them. It is time to be cautious about small caps funds and the hot thematic funds right now.

Q2 earnings were a disappointment. To some extent, things seem to have worsened from Q1 and there doesn’t seem to be an immediate recovery in sight. From whatever evidence we have gathered from the ground, Q3 is not looking to be a strong quarter either. This means that FY25 will end up being a year of single-digit earnings growth.

Financial services may be the most favourable from a risk-return perspective. The sector is witnessing healthy asset quality trends right now and capital adequacy is also high. Some of the private sector banks are trading at valuations lower than long-term averages.

We are positive on the healthcare sector which is a play on India’s strong demographics, rising income levels, and improvement in insurance penetration. There are significant export opportunities for companies in the CDMO market, especially in the backdrop of China plus 1. 

Indian IT services companies have started witnessing improvement in outlook driven by a sequential uptick in banking & financial services, its key customer segment. Strong deal wins over the last few quarters are a positive. The sector’s long-term growth potential will be driven by opportunities within areas such as cloud migration, cybersecurity, and data analytics.