All boats rise in market euphoria, but point of diminishing returns to kick in, say fund managers

The two domestic benchmarks have delivered double-digit returns in four of the past five years.

Amid a bull run, the surge in domestic liquidity is causing investors to overlook poor performances and sidestep the rigor required to distinguish between the good and the bad, leading fund managers said at the Moneycontrol Mutual Fund Summit 2024, held in Mumbai on August 22. They also noted that the overall lofty valuations mean that investors will need to factor in a long time horizon to make decent returns on equities.

"The strong liquidity has masked weaker performance, making it crucial to carefully evaluate companies and avoid the pitfalls of indiscriminate investing," said Roshi Jain, Senior Fund Manager at HDFC AMC. She further pointed out that the biggest downside of the current market euphoria is the erosion of discipline in evaluating stocks and valuations. "This exuberance has led to a tendency to paint all companies within a sector with the same brush, thereby diminishing the analytical rigor needed to distinguish between strong and weak companies in an environment flooded with liquidity," she added.

Typically, when market sentiment is driven more by exuberance than fundamentals, it can lead to the formation of a bubble characterized by euphoria and frothy valuations. In the market euphoria we are experiencing now, overvaluation seems to be across most sectors, said Rajiv Thakkar, Chief Investment Officer at Parag Parikh Mutual Funds. He drew attention to anomalies in the market. "There is a widespread spike in valuations across various sectors, including those at opposite ends of the spectrum, such as EVs and traditional autos, or quick commerce and retail players." He referred to this as a classic example of undisciplined investing, noting that "arguably, one will eat into the other; both cannot thrive." According to Thakkar, the stretched valuations across the market make it vulnerable to a significant risk of diminishing future returns.

Domestic benchmarks have delivered double-digit returns over the past five years, with the exception of 2022, even as BSE 500 companies reported sub-10 percent bottom-line growth for five consecutive quarters.

Several market experts have been warning for a while that non-institutional investors seem to be led into complacency based on the rosy returns of the past four years, which are irreplicable. Thakkar said, "There is a lack of experience among new-age investors who have only witnessed periods of strong returns." He warned that these investors, having been attracted by a bull market, may struggle to endure prolonged downturns, posing a risk to the market.

While acknowledging overvaluation, fund managers felt that it was necessary for investors to take a "longer" time horizon when investing in stocks. Jain argued that valuations seem expensive from a short-term viewpoint, but corporate earnings growth will eventually catch up over the long term. "Over a longer time frame, corporate earnings will likely grow in the low to mid-teens, opening up opportunities for compounding in certain sectors," she added.

Similarly, Balachandran sees a case for Indian equities sustaining their high valuations if GDP growth remains consistent. He expressed a more hopeful view of the market, believing that earnings growth is the primary driver of the current bull run. "Over the past few years, cyclical sectors have benefited from a recovery after prolonged underperformance. Margins have improved as weaker players exited these sectors."

Balachandran believes the market may continue to perform well if GDP growth remains strong. "However, if growth disappoints or there's policy paralysis, markets could struggle regardless of supply and demand dynamics," he added.

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