While lofty valuations of Indian stocks have been an eyesore for market experts for a long time now, the relentless non-institutional investors seem to fret little. Along these lines, brokerage firm Macquarie believes it is this unwavering support from non-institutional local investors through the financialisation of domestic savings that provides Indian equities with a long latent runway despite their lofty valuations.
While India does offer a promising growth trajectory, analysts at Macquarie still noted that in recent years, consensus estimates have rapidly adjusted to reflect this potential. As a result, India's earnings growth premium has diminished to near zero, compared to the usual 500 basis points premium, and Macquarie is now observing signs of expectation fatigue across various sectors.
This fatigue is also reflected in the fact that India has not experienced significant foreign fund inflows over the past three years. Rather, the primary driver for the outperformance of Indian equities has been a surge in domestic liquidity, fueled by the financialisation of savings (both direct and indirect participation) and increased formalisation through pension fund allocations, Macquarie noted.
Mutual funds have also joined the party, launching several new 'thematic' fund launches, which are in particular seeing the strongest traction from non-institutional domestic investors. On the flip side, Macquarie highlighted that promoters, multinational corporates, and private market investors have jumped to cash in on the robust returns.
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Reverberating the same idea, Kotak Institutional Equities believes that the current market sentiment is a potent mix of justified optimism among investors regarding India's robust macroeconomic fundamentals, cautious confidence in solid earnings growth over the next few years, and exuberance among non-institutional investors. KIE also believes that the latter is the most significant driver of the market at present, overshadowing both earnings and valuations.
The prevailing euphoria among non-institutional investors is such that it has significantly overshadowed fundamental factors, resulting in a notable disconnect between price and value across much of the market, and inflated valuations in other sectors, noted KIE.
KIE also pointed out that in this market filled with exuberance, even earnings have become less relevant, with the market rewarding modest beats in certain cases like IT services and ignoring large misses (Asian Paints and JSW Steel being two prominent cases) in Q1 FY25.
Despite this, non-institutional investors are carrying on with their unshakeable trust in high market returns regardless of price levels, bolstered by strong market performance over the past 3-4 years. Kotak reaffirmed Macquarie's observation that this confidence is evident in the substantial inflows into domestic equity mutual funds, driven by periodic NFOs (new fund offerings) and regular SIPs (systematic investment plans).
Furthermore, this steadfast faith in non-institutional investors over Indian equities is so strong that with the deepened local liquidity, Macquarie believes Indian equities can continue to demand higher valuations. "For instance, if financialisation of savings increases just 500 basis points over the next five years (from 50 percent to 55 percent), then we estimate this on its own would mean a 3.5-4.0 times increase in flow to equity markets - a powerful sponge to absorb drawdowns," Macquarie wrote.
For this reason, Macquarie also expects India to remain a rich bazaar with high relative valuation premiums unless conditions change to dent local liquidity.
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