Time correction likely ahead, expect low-to-flat returns in near-term

Earnings will be the primary driver for the equity market and any further slowdown could result in an extended period of consolidation, according to Rahul Singh, chief investment officer (CIO)-equities, Tata Asset Management. In an email interaction with Abhishek Kumar, Singh says that as the FY 2025 nears its end, the focus will soon shift to FY 2026 earnings estimates. Edited Excerpts:

 

Corrections in the recent past were fairly short-lived. However, this time it seems more prolonged. What has changed structurally? Has the correction provided valuation comfort? 

 

The volatility is the result of several factors, from China's economic stimulus measures to disappointing Q2 earnings season. The increased supply of equities through initial public offerings (IPOs) and qualified institutional placements (QIPs) further added to market pressure. Lastly, the prospect of a strong dollar means that emerging market flows will continue to be impacted.

 

I believe this correction is more about time than price, likely resulting in a period of low or flat returns, similar to what we witnessed between November 2021 and March 2023 period.

 

While the Nifty 50 trades at a higher valuation of around 21 times one-year forward earnings, valuations vary across the market. Large-cap stocks appear relatively cheaper compared to mid- and small-cap stocks. Therefore, investors should look at sectors with potential for positive earnings surprises or those that are attractively valued.

 

What’s your take on Q2 earnings? Has any sector delivered a surprise?

 

Disappointments outnumbered positives in Q2 earnings. The Nifty earnings per share (EPS) growth estimate for financial year (FY) 2025 has already come down to 6-7 per cent from around 12 per cent predicted at the start of the year. Urban consumption has slowed, while rural consumption has been sluggish for the past 18-24 months.

 

However, I do not foresee a significant further reduction in FY25 earnings estimates. As we near the end of FY2025, the focus will shift on FY2026 earnings.

 

The pharma and healthcare sectors have consistently delivered strong earnings, outperforming expectations. The healthcare segment, especially, has shown exceptional growth. Despite the impressive performance of the past year, the underlying structural factors suggest that earnings growth will likely persist for the next two to three years.

 

What will be the positive triggers for the Indian markets going ahead?

 

Earnings will be the primary driver from now on. Given the current high valuations, sustained growth is crucial. While current FY 2026 estimates remain unchanged at 15-16 per cent, the market's future direction will depend on the sustainability of these estimates over the next 4-5 months. If earnings growth falters and the slowdown persists into FY 2026, we could see a more extended period of consolidation.

 

Will the US election outcome weigh on India, other EMs?

 

A stronger dollar is negative for emerging markets from a flow perspective. Donald Trump’s return as the President could have some implications for Indian exporters. During his previous term, the primary concern was stricter visa regulations. However, the Indian IT firms had adapted to it by increasing the local workforce. As a result, these companies are now less exposed to visa-related risks.

 

Moreover, Trump's proposed corporate tax cuts could benefit Indian IT firms. The cash flow boost for US companies could translate into higher technology spending, providing the much needed catalyst for the India IT industry’s recovery.

 

Should investors consider raising their equity allocation? Which funds are best suited right now?

 

Investors should focus on asset allocation suitable to their risk profile at times like these. Hybrid categories like multi-asset and balanced advantage funds can be an option. It is also a time to focus on the diversified equity categories based on bottom-up style investing as the phase of sectors and thematics (barring a couple like banking and pharma) has ended.

 

The Tata Innovation fund, your first active NFO in more than year, has come at a time when the market has started to falter. Do you see the timing as an issue?

 

Over the past 12-24 months, the equity market has been largely driven by sectoral and thematic trends. However, there we are seeing a shift towards a bottom-up investment approach. Also, innovation is becoming increasingly vital across industries, given the pace of transformation. The innovation fund aims to identify companies that are either leading breakthrough innovations or making incremental advancements. This is a good time for such a fund as it is focused on companies and not sectors.

 

Are you making any sectoral shifts in your portfolios?

 

We expect positive earnings momentum in the pharma and healthcare sectors in the near term. The banking sector, which has underperformed over the last two years, now offers an attractive risk-reward profile. While challenges like slow credit growth and deposit mobilisation may persist for the next few months, current valuations suggest strong long-term potential, making it appealing from a three-to-five-year perspective. In contrast, IT sector valuations are approaching the highs seen during the Covid period, limiting further upside. Given recent market corrections, we are selectively focusing on these sectors for their growth prospects.