Market valuation stretched, a lot depends on earnings growth, says Waterfield’s Vipul Bhowar

Even with all the buzz around defence, capex and manufacturing themes, India’s equity rally is resting on a narrow base, says Vipul Bhowar, Senior Director & Head of Equities — Listed Investments at Waterfield Advisors. Valuations remain stretched and the next leg of the market will depend on whether earnings begin to broaden out, he adds.

Edited excerpts:

What is your take on the current market situation?

Three elements drive equities — liquidity, valuations, and rates. When two of them aren’t supportive, markets struggle. Between September 2023 and early 2024, we were in a rate up-cycle. Rates were high in India and the US, consumption slowed, liquidity dried up, and earnings softened. That’s why markets felt heavy. In the last nine months, the cycle has reversed. We are now in a rate down-cycle. Rates aren’t back to pandemic lows, but liquidity is back to pandemic levels thanks to rate cuts and the prospect of a CRR cut. With liquidity high, earnings recovering and valuations still reasonable, equities have support.

Earnings so far have been mixed. How do you see FY26?

Headline earnings look soft, but the nuance matters. Between 2020 and 2024, the recovery was broad-based — infra, consumption, discretionary all fired, barring FMCG. Since 2024, that breadth has faded. The rally is narrower, sector-specific. Defence, pharma, healthcare are leading; chemicals lagged; banking stumbled in 2024 but bounced back this year.

Even within sectors, divergences are sharp. In pharma, hospitals are hitting new highs, but diagnostics that peaked in 2021 remain subdued. The rally is narrower, but in select sectors, upside is strong.

Defence has been the big story. What explains the re-rating?

Two things. First, exports. After the US stepped back from NATO supply, European defence capex doubled. Europe lacks capacity, can’t buy from Russia due to sanctions or from China due to geopolitics. That leaves India — with scale, neutrality, and now precision engineering. Second, the domestic story. A decade ago, the government pushed localisation. A few private companies invested heavily then in aerospace, missiles, electronics. Today they are reaping the rewards, alongside rising government orders. And in defence, orders rarely get cancelled; they usually expand. That’s why valuations are high.

How does the market value defence stocks? PSUs or private players?

On order books. If a company says it will execute an Rs X order in three years with 50% margins, investors extrapolate profits across that period. As order books expand, valuations follow. And unlike FMCG where you can switch brands, defence suppliers are sticky. That sustains the re-rating. Private, always. PSUs carry obligations — on capex, on technology sharing. Private companies supply the precision parts: tyres, batteries, avionics. Once entrenched, they are irreplaceable. The next big wave after PLI will be precision engineering for defence — and private players will dominate.

Outside defence, what’s the key capex trend?

Corporate capex. For the first time in years, corporate investment has overtaken central government capex. Between 2020 and 2024, capex was government-led. Now corporates are spending aggressively. If you look down the market-cap curve, many mid- and small-caps have doubled fixed assets. That’s why they trade at premiums to the Nifty — investors are rewarding balance sheet investment.

What about IT and AI?

The structural challenge isn’t AI, it’s clients. Amazon, Google, Microsoft are setting up their own global capability centres in India. They’re insourcing work, which caps incremental growth for Indian IT services.

For a re-rating, either AI adoption must take off like cloud did during the pandemic, or AI services must create a new demand layer. For now, IT services will grow only 5–6%. That’s why allocations are shifting from services to product and platform tech — q-commerce, gaming, data. Zomato is a case in point: Blinkit’s growth drove sentiment even though profits lagged. Investors reward growth stories, messy P&L notwithstanding.

How has financials exposure shifted?

In 2020, it was 100% lending — banks, NBFCs, microfinance. Today, it’s closer to 60:40. The 40% is non-lending: insurance, exchanges, AMCs, wealth managers. Names like NSDL, CAMS, CDSL, listed insurers. Lending-heavy portfolios have underperformed the last four years; non-lending has done better.

Which sectors would you avoid now?

Two stand out: FMCG — it has underperformed for years with no trigger yet; and traditional IT services — growth is capped and valuations don’t reflect that risk. The opportunities lie where capex is structural: defence, infrastructure, energy transition, and specialised manufacturing.

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