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Business News›Markets›Expert Views›ETMarkets Smart Talk | Don’t chase growth at any valuation; rising US yields can pressure P/E multiples: Manish Kumar

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ETMarkets Smart Talk | Don’t chase growth at any valuation; rising US yields can pressure P/E multiples: Manish Kumar
Synopsis

Midcap and smallcap stocks are hitting record highs, but rising valuations and higher US Treasury yields could challenge the rally. ICICI Prudential Life Insurance CIO Manish Kumar discusses earnings visibility, domestic liquidity, FII selling, IPO supply and valuation discipline, while explaining why investors should avoid chasing growth at any price.

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Indian equities have been showing an interesting divergence—midcap and smallcap indices are at fresh record highs, even as the broader market remains in consolidation mode.



Stronger earnings momentum and steady domestic flows have supported SMIDs, but rising valuations are making stock selection and valuation discipline increasingly important.

Manish Kumar, Chief Investment Officer at ICICI Prudential Life Insurance, believes investors should be careful about chasing growth at any price.



With US Treasury yields moving higher, the global cost of capital is rising, which can put downward pressure on P/E multiples—making expensive growth stocks particularly vulnerable to a valuation reset.



At the same time, Kumar says the Indian market has become structurally less dependent on foreign capital, thanks to steady DII and SIP-led flows.




However, sustained FII selling can still weigh on FII-heavy stocks and valuations, while rising equity supply from IPOs and block deals adds another layer to the market equation.

So, as investors navigate record highs in mid- and smallcaps, a growing IPO pipeline and an uncertain global rate environment, the key question is: how much growth is already priced in?

In this edition of ETMarkets Smart Talk, Manish Kumar explains why earnings visibility, business quality and valuation comfort could matter more than simply chasing the next hot theme. Edited Excerpts –

Q) The headline story is interesting: Midcap and smallcap indices are at fresh record highs, but the broader market has been consolidating for weeks. Are we looking at a healthy rotation beneath the surface or growing complacency?

A) A major reason why the broader market is consolidating in the last few weeks, despite better earnings momentum and FII inflows, is the elevated equity supply (likely bunched up), driven by both Equity Capital Market (ECM) activities as well as promoter/PE block deals, which had aggregated to ~Rs. 1tn in the month of August vs. institutional inflows of just ~Rs. 0.7tn (~Rs. 0.5tn DIIs, ~Rs. 0.2tn FIIs) [Source: Axis Research].



Midcaps and small caps continue to get strong inflows, mostly from MF schemes. Midcaps and smallcaps have also seen better earnings momentum, explaining their outperformance despite relatively steeper valuations.

Q) The biggest risk with record highs is that investors confuse momentum with quality. Are we seeing that happen again in parts of the mid- and smallcap universe?

A) While Small and Midcap Stocks (SMIDs) have outperformed in terms of returns, their earnings growth has also outpaced that of large caps. Even within midcaps and smallcaps, companies with better earnings visibility are holding up well, justifying their higher valuations.



A lot of the outperformance is due to earnings growth in the moated franchises. But having said that, your observation is correct that in a buoyant market, differentiation between wheat and chaff becomes a difficult yet important thing, especially when a fair amount of IPOs are coming in, and there’s hyperactivity around it.

Q) Are we entering another phase where investors are buying anything that is remotely linked to capex, defence, manufacturing, power or AI?

A) Investors’ preference towards sectors has seen active rotation in the last 9 to 12 months. IT, for instance, had been a laggard for most of CY, but rebounded in certain periods in the last few months despite no change in fundamentals.



Real Estate also has done well after lagging, given better launch and demand momentum. Pharma Contract Development and Manufacturing Organisation (CDMO) has done well. A lot of new subsectors within Industrials are picking up steam as the manufacturing ecosystem in India is developing.



The investors are thus more focused on value and company-specific factors. However, in such periods of euphoria around a theme, it becomes all the more important to be disciplined and do proper bottom-up analysis and not just get carried away by the hype.

Q) Can domestic liquidity permanently offset sustained FII selling, or are we underestimating the influence foreign investors still have on valuations and sentiment?

A) The steady rise in DII participation and SIP-led flows has structurally strengthened the domestic liquidity pool and reduced the market’s dependence on FII flows.



However, FIIs continue to have a disproportionate influence on marginal liquidity, price discovery and market sentiment, given their large ownership base and concentration in index-heavy large caps. Despite a sharp FII exodus, FIIs still own ~16-17% of Nifty-500.



Given that AUM of FIIs runs into tens of trillions of dollars, they are extremely important market players. Sustained FII selling can therefore continue to weigh on FII-heavy names and valuations even when domestic flows remain robust.



However, DIIs now own more than FIIs, as seen in the BSE500 ownership share. DIIs now lead FIIs in ownership, for the first time ever. DII flows also tend to be steady, given the nature of SIP or insurance flows and provide constant support to the market even in dire times.



Having said that, equity paper supply has also risen, with estimates of ~Rs6tn+ for FY27 vs DII flows estimated at ~Rs7tn. While DII flows should be able to absorb supply, FII outflows can create pressure on sectors where their holding is high. Thus, for markets to rally sustainably, FII inflows are very important.

Q) The market is now watching the US Fed closely. How sensitive is India to the possibility that US rates may remain higher for longer?

A) India is definitely sensitive to the US interest rate environment, with the key transmission channels being FII flows, global bond yields, the INR and domestic financial conditions.



Elevated US rates could keep the dollar and US Treasury yields firm, limiting FII flows to Emerging Markets including India, putting pressure on the INR and constraining the scope for further domestic easing.



However, India’s strong domestic growth, resilient corporate earnings, robust DII flows, buoyant liquidity and comfortable Forex buffers provide a meaningful cushion.



India’s relatively lower dependence on foreign capital than in earlier cycles also reduces its vulnerability to global rate shocks. Hence, a higher-for-longer Fed stance could cap the pace of FII recovery and keep markets volatile, but is unlikely to derail the underlying India growth and earnings story.



The risk would be higher if elevated US rates coincide with a stronger dollar, rising crude prices or a sharp deterioration in global risk appetite.

Q) US Treasury yields have been moving higher, and historically rising yields tend to trigger a risk-off sentiment by making safe US assets more attractive and tightening global liquidity. How serious a risk is this for Indian equities, particularly expensive mid- and smallcaps?

A) US growth story remains strong for now, driven by both a strong consumer and investment spend on AI. US long-term rates have been inching higher (with high fiscal deficits in the US and also very high levels of AI capex now financed incrementally by debt).



However, this is not a systemic risk yet. Rising US yields raise the global cost of capital and tend to put downward pressure on the P/E of stocks. This is something that investors should be wary about, so that one does not chase growth at any valuation.

Q) The IPO pipeline is exploding. Are investors buying businesses—or just buying the hope of listing gains?

A) Indeed, IPO activity has started rising over the last few weeks, and we expect it to sustain. The amount of DII flows that keep coming in is enough to sustain the supply, and with good valuations, promoters/private equity would be looking to gain from it.



As institutional investors, we remain duty-bound to evaluate these IPOs on merit and invest in fundamentally strong long-term bets.

Q) If you are sitting on 30-40% gains in mid- and smallcaps, what should you do today—hold, trim or rotate?

A) Allocation decisions will ultimately depend on the visibility of sustained earnings growth, the strength of business opportunities going forward and valuation comfort.



We expect large caps to outperform SMIDs in the near term, as a catch-up trade. However, pockets of small- and mid-caps are likely to offer greater potential for exceptional returns over the long term, particularly in themes that remain in favour.



Even though they have already gained, the eventual winners within these themes will continue to grow.



Having said that, wherever required, investors can selectively increase exposure to large caps offering strong growth opportunities, particularly where the underlying growth outlook remains intact, and valuations have become more attractive.



(Disclaimer: Recommendations, suggestions, views, and opinions given by experts are their own. These do not represent the views of the )

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