Midcap space most expensive segment of the market: Aniruddha Naha, CIO, Alternatives, PGIM India AMC

Indian equities have done well since Covid and have generated strong returns. The topline growth for companies has moderated and given increased cost pressure, the next two quarters could see subdued earnings growth. Given the inflation scenario, rising freight and raw material costs, and subdued earnings growth over the next two quarters, one could ideally temper down return expectations for the calendar year to high single-digit or low double-digit returns. We remain cautious in the near term but are extremely constructive in the long term. This will be the year to build portfolios for the next three to five years.

The positive triggers are largely discounted in the near term. Strong topline growth for corporate India could be a surprise positive to look out for. On the other hand, higher commodity and crude oil prices could impact inflation and, eventually, the trajectory of interest rates going ahead. The markets may underestimate the inflation levels globally. 

Markets might look fairly valued in the near term, but there are always stocks and segments where the opportunity lies in good businesses where valuations are reasonable. The midcap space is probably the most expensive segment of the market due to the limited 150 stocks in that segment. The small and microcap space, as we define it, comprises companies with a market capitalisation of more than ₹1,000 crore, with around 1,200 companies. Although the segment might be fair to over-valued, there are pockets of reasonable valuations.

FPI flows depend on the macro outlook, such as inflation and growth, along with the size of the opportunity, whether it is part of an allocation in the overall emerging space or an India-dedicated mandate and valuations. India enjoys very good macro conditions and a market where the size of the opportunity is large. In the near term, valuations could keep the FPIs a bit concerned, but in the medium to long term, given the opportunity size and the growth outlook, one can be fairly positive on capital inflows.

The central banks are pointing to an easing cycle with an expectation of rate cuts from June, as indicated by the US Fed. The fact is that commodities and crude prices are inching up. In the process of every country trying to manufacture and get self-sufficient and geopolitical tensions taking over, inefficiencies are getting built into the global trade, which is inflationary and reasonably structural in nature. The West Asia crisis will impact freight rates and build in cost pressures. In such a scenario, it looks unlikely the central banks will rush in to cut rates, and higher rates may remain sticky for longer. In case rates are cut, you will invariably see risk appetite coming back, which would be positive for both emerging markets and India.

The December quarter earnings growth was more or less in line. The topline growth has been subdued and worrisome. Margin expansions have led to better profit growth. Going ahead, one needs to keep a tab on incremental margin levers and cost pressures. The earnings for FY24 and the first half of FY25, could be reasonably subdued and, at best, a high single-digit number.

Given where the markets are, sectors with good earnings growth are reasonably valued, and the chances of any big rerating are limited. Private sector banks and pharma could be two sectors with pockets of opportunity. The next twelve months will be a year of stock picking rather than sector allocation.