Risk-on for foreign investors: Fed rate cut done; valuation, earnings to drive FII sentiment towards India

Indian markets' high valuation is one of the key factors holding back FIIs from significantly increasing their exposure.

Foreign investors are expected to carefully weigh their next moves into Indian equities and other emerging markets following the US Federal Reserve’s aggressive interest rate cut delivered on September 18.

While a 50 basis points rate cut would typically encourage flows into riskier emerging markets such as India, valuation concerns and the broader outlook for earnings growth will be crucial in determining whether the Indian market can maintain its appeal.

Valuation concerns likely to keep foreign investors cautious

One of the key factors holding back foreign institutional investors (FIIs) from significantly increasing their exposure to India has been the market’s high valuations. Mark Matthews of Bank Julius Baer & Co flagged India’s elevated market valuations, noting that “Indian markets have gone up too much and are very expensive."

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In a conversation with CNBC TV18 ahead of the US Fed rate cut decision, he said that he expects the market to consolidate from here on, and does not see FIIs buying heavily in the current environment. Instead, domestic institutional investors (DIIs) are likely to continue driving market flows, with FIIs taking a more cautious stance.

Timothy Moe of Goldman Sachs said that unlike other Asian markets, the US Fed rate cut has had a more limited influence on India, primarily as high valuations are holding investors back despite long-term growth potential.

But positive earnings growth may compel them to look towards India

Despite concerns over valuation, there are signs that earnings growth may support Indian markets in the medium to long term. Timothy Moe remains optimistic about India’s economic growth, projecting a GDP expansion of over 6 percent, and corporate earnings growth of 14-15 percent over the next five years.

This could bolster confidence among investors, especially as India’s economic fundamentals remain strong compared to other emerging markets like China, where sentiment is weaker, he said to CNBC TV18 in the run-up to the Fed meeting.

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Arul Selvan of Cholamandalam Investment said that India’s growth trajectory remains positive, but the Reserve Bank of India (RBI) may hold off on rate cuts for now to address domestic inflationary pressures.

Meanwhile, Karthik Kumar of Axis Mutual Fund pointed out the sector rotation underway and the switch back to quality stocks, which could provide some level of comfort to FIIs, particularly in low-beta names and consumer staples.

Sector-specific opportunities in Indian markets for FII flows

Foreign investors may also shift their focus to specific sectors that could benefit from a more favourable economic environment. Andrew Holland of Avendus Capital said in an interaction with CNBC TV18 that a weaker dollar could serve as a tailwind for Indian metal stocks, while Parvez Akhtar Qazi of Nuvama Group sounded a bullish note on real estate, citing strong demand in the sector for the next three years. However, Qazi also warned that most real estate stocks have moved beyond valuation comfort, which could temper FII enthusiasm.

The IT sector, which has seen some volatility recently, may also present a buying opportunity for foreign investors. Karthik Kumar of Axis Mutual Fund said that the underperformance of midcaps and small caps relative to large caps has narrowed, and his firm has reduced its underweight position in IT stocks. FIIs may prefer large-cap IT stocks to re-enter the market.

China’s struggles boost India’s appeal

India’s attractiveness has also been boosted by the poor sentiment in China, which has led foreign investors to shift their focus to Indian markets. “Sentiment in China is so poor that India has been standing out,” said Andrew Holland. However, he cautioned that if China’s economy turns around, it could attract flows away from India, especially if valuations remain a concern.

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