Focus on sustainable earnings growth, avoid overpaying in market euphoria: PGIM India Mutual Fund cautions investors

Indian markets rose around a percent in intra-day deals today, extending gains for the 8th straight session after US Fed Jerome Powell's indication of a rate cut next month was cheered by investors. At the Jackson Hole Symposium, Wyoming, Powell hinted, "The direction of travel is clear, and the timing and pace of rate cuts will depend on incoming data, the evolving outlook, and the balance of risks.

From the Indian market perspective, this is significant since it will strengthen the minority view espoused by the two independent members of the MPC in favour of rate cuts in the last monetary policy meeting. Since core inflation in India is only 3 percent and economic growth is turning slightly sluggish, the MPC is likely to cut rates by 25 bp in the next meeting.

PGIM India Mutual Fund: Market Outlook and Valuation Concerns

PGIM India Mutual Fund expects that in the short term, some events could have an impact on markets in general. These include regional conflicts and their resolution/continuation, interest rate actions by central banks and Yen carry trade unwinding.

In a recent market outlook report, it said that strong re-rating in markets in the last one year may imply that we (Indian markets) have borrowed some returns from the future. The fund identified pockets of overvaluation and exuberance, particularly in lower market capitalization segments, where high earnings expectations are already reflected in lofty valuations. PGIM warned that if earnings do not meet these expectations, there could be a risk of earnings downgrades and multiple de-ratings.

"We find pockets of over valuation and exuberance especially in certain lower market capitalization segments which are already factoring a good amount of earnings growth along with lofty valuations, where, if earnings do not materialize then there is possibility of earnings cut as well as multiple de-rating," said the MF.

It believes that, currently, large caps are relatively reasonably valued vis-à-vis mid and small caps. However, the fund also believe that in the long-term, all segments offer good growth opportunities due to sustainable intrinsic value growth driven by superior economic growth in India.

The report advised investors that Earnings growth should be the key driver of returns hereon, and companies that can sustainably deliver it without taking too much balance sheet risk and redeploy capital in a prudent manner should outperform those which are unable to deliver the same. It also cautioned against getting swept up in market euphoria and overpaying for temporary growth, emphasizing that earnings growth should be the primary driver of returns moving forward.

"It is also important that we do not get carried away in the euphoria and not overpay for fleeting growth," further said the report.

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