In FY25 and FY26, stocks were saddled with high valuation and decelerating earnings. But valuations are now correcting and earnings growth is supported by higher nominal GDP growth, improving the outlook for Indian equity, R Sivakumar, CIO, Axis Mutual Fund, told businessline.
Revenue as well as earnings growth were pretty robust in the first quarter of FY27 despite the US-Iran war. What is the outlook for rest of this year?
To set the context, we were on very low earnings growth over the last couple of years, primarily due to low nominal GDP growth. That’s the growth which can be expected from corporate sales and earnings since total gross value added, in a sense, is a measure of profits in the economy. But in the March quarter of FY26 and June quarter of FY27, we moved into double digits nominal GDP growth.
Last year, CPI inflation was between 0 and 2 per cent. So even though we had 7 per cent real GDP growth, we had only 8 per cent nominal growth. Now, CPI is accelerating. So that same 7 per cent real growth is translating into 11-12 per cent normal growth.
That 8.5 per cent nominal GDP growth in FY26 is the slowest annual growth since fiscal 2003, except for the Covid year. So, we are bouncing off a 23-year low into a more normal double-digit growth for the economy. We expect the momentum to continue for some time. The RBI forecasts inflation of around 5 per cent for the coming year. If that holds, we should see earnings growth well into double digits for the rest of the year and potentially beyond.
Isn’t high inflation hurting operating margins?
In aggregate, yes. The companies which consume commodities will suffer a little bit when commodity prices rise, but commodity producers will gain. So yes, there are winners and losers in this, but in aggregate things are looking up.
For buyers of commodities, operating leverage comes into play. If fixed costs stay relatively stable, even if your margins shrink, with your overall business expanding rapidly, profits will still grow, even if your margins come down slightly on a unit basis. Another aspect is the sharply depreciating rupee. This, while not good at one level, has supported the export sector, which is relatively high value added and more profitable. These factors explain why, despite the rising commodity prices, we are seeing margins and profits holding up.
Indian market is one of the worst performing this year. Has it helped cool some of the overvaluation?
If you go back two years ago, which is when the correction started, Nifty was trading at 23, 24 times earnings. And earnings growth was in single digits. That became a big problem in attracting foreign investors. On the other hand, if you look at the rest of the world, thanks to the AI boom, countries like US, China, Korea and Taiwan benefitted from accelerating earnings, but valuations were more reasonable there.
But now, at Nifty level, valuations are down from some 24 times to 18 times. Second, earnings have started accelerating. So, in comparison to the rest of the world, the Indian story has improved. Today, many of the other markets have suddenly become as expensive or more expensive than India. I think, this will lead to rotation of funds back into India. The other factor favourable to India is, the doubts being raised about AI and the profitability of AI companies.
At index level, valuations have come down because of specific sectors. Banks, IT, some consumer stocks and oil and gas stocks have become cheaper. These four sectors make up almost 50-60 per cent of the Nifty50. The rest of the market is still not cheap.
When you look beyond large-cap, mid-cap and small-caps have continued to run up and have become more expensive. But that is because that’s where earnings growth is. So, market today is very clearly distinguishing between companies which are able to deliver earnings growth, where stocks are being re-rated.
If earnings growth is below a certain level, say 12 per cent, then the stocks have been de-rated. So, the first question is not about valuation, it’s about earnings growth. The next question is, how much are you willing to pay for that growth? If growth is there and it is accelerating, you don’t mind paying for it.
But do you agree that there is froth in valuation in some pockets?
I agree. Take the AI boom: expectations of continued global growth and new data centres in India have driven up shares of potential power suppliers, even though the facilities do not yet exist, orders have not been placed and the beneficiaries remain uncertain. Some mid- and small-cap stocks reflect expectations that may never materialise. We must look beyond fashionable themes and assess whether companies can deliver what their prices imply. A premium may be justified if they can; otherwise, when valuations outpace fundamentals, we should exit or avoid those stocks and sectors, even if prices keep rising, and seek better valuations or greater growth certainty. Active management means continually asking whether a theme has played out, retains potential or offers less than opportunities elsewhere.
There is a lot of concern about US bond yields moving above 5 per cent? How do the rising yields impact Indian equity?
US Treasury yields are rising because the economy remains strong, supported by robust GDP growth, data centre investment and hotter-than-expected inflation. Since yields are increasing alongside growth rather than because the Fed is trying to trigger a slowdown, this is not inherently negative for risk assets. The Fed still sees rates as restraining inflation, not endangering growth. However, higher yields raise companies’ cost of capital and the returns needed to justify valuations. If the cost of capital rises from 9 per cent to 12 per cent, fewer companies can meet that hurdle. Businesses with strong growth, free cash flow and balance sheets should benefit, while weaker companies may be de-rated, widening the gap between winners and losers. We would reassess if rates became restrictive enough to threaten global growth, but we are not there yet. The risk is more immediate for the US: with about $40 trillion in debt, refinancing at yields of 5-5.5 per cent rather than an average coupon of roughly 3.5 per cent could add about $800 billion to an already large annual fiscal deficit. The US has options to manage this, but higher interest costs remain a concern. For India, the main near-term impact is the higher cost of capital, which we continue to monitor.
What in your view can get the FPIs back? Are you in the camp that believes that changes are required to the long-term capital gains tax and STT?
You pay capital gains tax on capital gains. So first, let’s fix the gains. Let’s give the reasons for investors to invest, and then we’ll worry about what tax rate will apply. Foreign investors prioritise growth and value. Two years ago, India offered weak growth and high valuations; today, valuations have moderated and earnings are accelerating, making the market more attractive. Foreign buying has resumed intermittently, but sustained inflows will depend on India delivering stronger earnings growth than competing markets such as Korea, Taiwan and Japan, which have benefited from the AI boom. Tax matters, but returns matter more. Improving exports, domestic demand and manufacturing offer opportunities, though a major revival in foreign flows will require double-digit GDP growth to continue for several quarters.
What is your view on the continuous inflows through mutual fund SIPs? Is it a good thing or not so great?
One question people ask me is that have retail investors in India given an exit to the foreigners? Indian retail investors have not provided an exit for foreign investors. Mutual-fund inflows have largely gone into mid-cap, small-cap, flexi-cap and multi-cap funds, while foreign investors have sold large-caps because those dominate their holdings. Retail investors have invested wisely; concern would arise only if a deep drawdown persisted for several quarters.
The larger issue is the external sector. Foreign portfolio investors have sold Indian equities for nearly three years, while India runs a current-account deficit and net FDI turned negative last year. Although domestic flows can offset foreign selling in the stock market, weaker portfolio and direct investment can pressure the rupee, especially when oil prices rise. Gross FDI remains healthy, but private-equity exits, overseas borrowings of Indian subsidiaries and outbound acquisitions have reduced net FDI. India therefore needs to attract more long-term foreign capital. This is primarily a currency and external-sector concern rather than a stock-market issue.
What’s your view on the banking sector? Many are becoming positive on it, particularly public sector banks…
Banks are benefiting from three key factors: growth, asset quality and margins. System-wide credit growth has accelerated from about 10 per cent a year ago to 18-19 per cent. Concerns that the West Asia conflict would increase non-performing assets have not materialised, and asset quality is near multi-decade highs. With repo rate hikes underway, net interest margins should also normalise. Despite these positives, bank shares have lagged largely because foreign investors—who hold substantial stakes—have continued to sell. We remain positive on both public- and private-sector banks, with a preference for private banks because of their underperformance and attractive relative valuations. Public sector banks have also performed well, supported by stronger liquidity and balance-sheet management, while private banks are now regaining momentum. Overall, banks combine robust growth with reasonable valuations, making them one of the emerging value opportunities in an otherwise expensive market.
What are the key themes that you would be looking for in the quarters ahead?
The key theme is manufacturing, which is benefiting from both domestic demand and exports. After years of weak private-sector capital expenditure, manufacturing investment has rebounded over the past two years, particularly in power, industrials and auto ancillaries. However, manufacturing still accounts for only about 13 per cent of GDP, and overall capital formation, including infrastructure, remains relatively stagnant. Exports should remain an enduring theme, supported by free-trade agreements and rupee depreciation. We also favour banks. We are cautious on consumer stocks: growth may recover, but valuations are still expensive. Broadly, business-to-business sectors offer greater opportunities than business-to-consumer segments. Our portfolio therefore emphasises manufacturing and banks, while staying underweight in less attractive sectors. Overall, there are more opportunities than we can invest in.
What would your advice be to investors at this point? Returns from equity has been stagnating and frustration is growing…
Over the last five or six years, the number of investors have dramatically increased. Many of these investors, who came in post 2021 saw the markets just going up every year and they all thought this is the only way to go. And then suddenly when you have two years of consolidation, they think, oh my God, this is a major problem with my portfolio. No, it is not. It is okay. And this kind of sideways consolidation is any day better than a large fall in the market.
The second thing is that post 2023 when the tax on debt funds changed, we did see a lot of investors switch their asset allocation away from debt into equity. This is also a period when equities were booming so everybody thought this is the place to park my money. This is just a lesson to all of us that have an asset allocation.
There will be near-term volatility but we hope that the volatility will be on the upside rather than the downside. I think the opportunities for investors like us happens often when there are shake-outs. But medium-term, long-term view continues to be very, very positive.
