Escalation in Middle East may drive correction in overvalued Indian stocks, says Kotak's Gupta

An escalation of hostilities in the Middle East makes India vulnerable to oil price shocks and could result in a correction in stock prices, which already seem overvalued based on earnings estimates for the current fiscal, according to Pratik Gupta, chief executive officer and co-head of Kotak Institutional Equities.
Gupta said this could cap market upside over the next few months but expects earnings to pick up in the second half of the current fiscal. Foreign portfolio investors acknowledge India's strong macros and resilience of domestic flows, but await a correction to make large fresh investments, he said.
Edited excerpts:
We expect net profits of the Nifty 50 Index to grow 12% in FY26 and 15% in FY27, following a modest 6.4% growth in FY25. Diversified financials, metals & mining, oil, gas & consumable fuels and telecom will provide the bulk of the incremental profits for FY26 of the Nifty 50 Index. The sector-wise trends for the broader Kotak coverage universe of almost 300 companies are very similar to the sector-wise trends for the Nifty 50 Index. We estimate that the metals & mining sector will account for 22% and 16% of the incremental profits of FY26 of the Nifty 50 Index and KIE coverage universe, respectively.
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We could have said that the worst is behind us if it weren't for the latest conflict between Israel and Iran, which has the potential to escalate and result in a further spike in global crude oil prices. However, if this conflict doesn't escalate, India's macroeconomic outlook is very strong and corporate earnings should pick up in 2HFY26. Nonetheless, the Nifty is not cheap as it is still trading at 22x FY26 earnings, which is expensive relative to its own history as well as in relation to local bonds or other emerging markets. Hence, it is a bit unrealistic to expect meaningful upside to markets in the next few months, although the long-term India equities' story still remains attractive.
Overall, lower interest rates will help, but that alone cannot spur corporate loan growth. Many corporates are holding back on large capex plans due to the weak demand environment, high competitive intensity, low capacity utilisation and/or global trade uncertainty. While the government cannot do much about global factors, there needs to be a fresh push for economic reforms like deregulating and improving ease of doing business (especially for SMEs), land and labour reforms, accelerating government capex on infrastructure, etc. For now, it appears that any strong growth in private sector capex is still some time away.
In general, given the risks of a slowing global economy, we would prefer domestic plays versus export-oriented plays. Also, most large caps offer better risk-reward vs small/mid-caps at current valuations. In terms of sectors, we like banks, NBCFs (non-bank financial companies), life insurance, telecom, hotels, and real estate. We would avoid the consumer staples, IT services, oil marketing PSUs, chemicals, and the metals sector in general.
Foreign investors have been cautious on India due to our high headline valuations (vs other emerging markets). However, they have been very surprised by the resilience of domestic flows and how Indian markets have managed to sustain high valuations despite weak earnings growth in FY25. FPIs acknowledge the strong medium-term growth prospects for India and the strong macroeconomic position of the country, especially relative to its peers, but they're largely staying away due to our relatively expensive valuations. Most FPIs are awaiting a correction in India to make large fresh investments. It's also worth noting that most FPIs invest in India from their global EM (emerging market) fund allocations, and such funds have not seen meaningful inflows this year as yet. This may change as and when money flows out of the US–possibly due to concerns over a weakening US dollar–and at that time, one may see EM funds getting strong inflows. India would also then get its fair share of strong FPI flows.
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While there have been many large transactions in the last 4-5 weeks involving the sale of shares by promoters/PE funds, this is not necessarily a negative sign across the board. In many such exits, there were company-specific reasons where the promoters needed to raise cash for some other reason, and it wasn't a reflection on the business or stock price prospects. A sale by a promoter or a PE who is typically better informed about their company's prospects may raise investor concerns, but there have been numerous instances over the years where investors have made money by buying from promoter or PE stake sales.
Also, the quantum of such block deals recently (about ₹65,000 crore in the past one month) may seem like a big amount in absolute terms, but it's still small relative to our India market cap of about ₹450 lakh crore.
The IPO pipeline is strong as there are many promoters or private equity funds who are looking to monetize a part of their stake given good valuations they can expect in the current environment, and/or companies need fresh equity capital to fund their growth plans.
Retail investors should be very careful with any IPO, not just those priced at high multiples. Such companies don't have a public track record of profitability or of their ability to manage tough business downturns. Investing in IPOs requires a sophisticated understanding and analysis of the industry, the company and its management, which most retail investors are typically ill-equipped for. Investing in an IPO just because it is perceived to be "hot" or is trading at a premium in the grey market is a common mistake made by many retail investors.
It doesn't mean that one can't make money from IPOs, as many good companies have made money for their IPO investors, and some good businesses will go public this year, too. It's just that the ordinary retail investor should be more careful and get professional advice before investing in IPOs.
Also read | 'Slowing earnings growth fails to dent India's image as equity haven'
For global emerging market funds, China is certainly back on the radar given that a trade deal with the U.S. is now almost finalized, given how attractive valuations are there vs those in other countries, and given that most global funds are still neutral-to-underweight China.
India is seen as a very good market to invest in the long term, but EM investors have not been too keen on investing at current valuations with earnings growth that is still not showing any signs of acceleration.
Given the uncertainty over Trump's economic policies, the high fiscal and current account deficits in the U.S., and the risk of a weakening dollar, some global funds have been incrementally moving money to other regions such as Europe, Japan and Asia.

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