Investors need to temper their expectations: Nippon India Mutual Fund CIO

“Returns are unlikely to exceed earnings growth,” he said, adding that the consensus expectation for earnings growth is in the mid-teens. Valuations are not cheap, he said, noting that large caps currently have more reasonable valuations than mid and small caps.

Bhan also said any significant increase in the 10% long-term capital gains tax on listed equities would dampen investor sentiment.

Here are some edited excerpts from the interview.

CPI inflation surprisingly rose to 5.1% year-on-year in June with a sharp uptick in the prices of food, beverages and vegetables. The RBI governor recently said that with inflation around 5%, it is premature to talk about interest rate cuts. What is your perspective on this and what are your expectations from the August policy meeting?

Inflation in India is largely driven by elevated food prices. Core inflation has remained very well contained at around 3%. The recent hike in mobile tariffs will put upside pressure on core inflation in coming months. Overall, inflation is likely to remain benign but higher than the RBI’s comfort level of 4% throughout FY25.

The RBI may also want to see progress on the monsoon and a more durable decline in food inflation before changing its neutral stance. Given the fact that growth in India is strong and the economy needs higher neutral real rates for longer, a status quo is likely in the August policy meeting. We expect rate easing to start only in the second half of FY25 and not before the US Fed delivers rate cuts.

What tops your Budget wish list? Which sectors could be in focus after the Budget?

The government is going into this Budget in a strong fiscal situation. Thanks to surplus dividends from the RBI and general tax buoyancy, the government will have enough space to achieve fiscal consolidation while allocating extra to both capex and consumption-inducing expenditure.

The supply-side focus that the government has demonstrated over the years won’t be altered as such. Infrastructure-related sectors will continue to see traction. Similarly, we will be looking for any rationalisation of personal income tax, which would add to the purchasing power of consumers.

With the market flirting with record highs, should savvy investors chase the potential of growth stocks or embrace the stability of value stocks for the best returns?

Rather than getting into the debate on growth versus value, one should focus on getting stocks with the right combination of growth and value. The market is reacting to earnings. In both high-valuation growth stocks like retail and capital goods, and value-oriented public sector companies, earnings are being recognised.

Regardless of whether the market is at a record high, one should maintain a balanced approach and try to identify earnings-driven, bottom-up opportunities to create alpha.

Overall, do you foresee a significant correction in Indian equities? How are the valuations across large-cap, mid-cap, and small-cap stocks?

Valuations aren’t cheap, given the strong performance of the market. Valuations have outpaced the underlying earnings growth over the past three to four years. Even so, corporate earnings growth remains broad-based, and the corporate-earnings-to-GDP ratio is increasing.

That said, after massive gains in the past 12-18 months, investors have to moderate their expectations. Returns are unlikely to be higher than earnings growth. Having said that, the consensus on earnings growth is expected to be in the mid-teens. Valuations are more reasonable in large caps than in mid and small caps at this point.

What could dampen investor sentiment after the Budget? How big is the concern about global geopolitical conflicts, given that some companies are still reporting that global crises have affected their volumes?

Any material increase in the long-term capital gains tax on listed equities from the existing 10% would dampen investor sentiment. Geopolitical risks are real, but they typically don’t have a lasting impact on investor sentiment if they don’t influence the earnings outlook. Sporadic geopolitical events that temporarily affect earnings, like supply disruptions, will not have a major impact on the market.

The election outcomes in major economies such as France and the UK may heighten uncertainty in the run up to the US presidential election in November. Could this lead to volatility in foreign institutional investor (FII) flows?

Elections per se don’t alter the economic growth trajectory. Foreign flows are affected by significant changes in earnings or risk premiums. While occasional bouts of volatility can occur, the elections won’t significantly affect flows as they are usually not major liquidity events. Also, we now have very strong and sustainable domestic flows, which minimise the impact of measured foreign outflows.

In 2024, gold was one of the best-performing assets. This positive momentum was fuelled by expectations of a rate-cut cycle, escalating geopolitical tensions, central bank purchases, and increased volatility in the equity markets. Do you anticipate a repeat of the outperformance seen in 2022 and 2023?

Gold has proven to be a good asset class as far as diversification is concerned. With the possibility of a global rate-cut cycle gaining momentum and the US dollar softening, gold will perhaps provide upside.

Elections and other geopolitical risks also add to gold’s prospects and therefore there is merit in considering some allocation to gold. However, it is difficult to predict with certainty whether a repeat of 2022-2023 will occur.