<p>Indian equities have spent much of this year trading toward the top of their recent range. The Sensex is not at a valuation record and price-to-earnings ratios in the low-twenties are broadly in line with what India has sustained for much of the past decade. Even so, indices have delivered handsome returns and the wobble earlier this year, when stocks shed more than a tenth of their value, has been quickly forgotten. The question now is less whether valuations are extreme and more what might cause them to adjust – and what signposts investors should watch over the next two or three years. Judged by long-term averages, Indian equities appear only slightly over the norm, but they are not cheap. A multiple in the low-twenties assumes that profits will grow steadily and that policy, liquidity and sentiment will remain supportive. Much depends, therefore, on the “E” in those ratios. Corporate profits, after the post-pandemic surge, have cooled. Earnings growth has narrowed, with much of the incremental profit coming from a small cluster of firms in telecoms, banking, autos and metals, while many others have reported flat or weakening results.</p><p>Another lens is volatility, often the most revealing gauge of market mood. India’s volatility index, derived from options prices, has in recent months hovered at subdued levels. In plain English, investors seem untroubled, hedging is inexpensive and risk appears scarce. Low volatility is not inherently ominous; yet when paired with relatively high valuations and slowing earnings, it can suggest that markets have become a touch too serene. A modest shock – a geopolitical flutter, stiffer global financial conditions or another quarter of underwhelming profits – may be enough to jolt sentiment. Gold’s occasional corrections and swings in the dollar offer further clues about global liquidity. If there are vulnerabilities, they lie increasingly outside India rather than within it. Domestic fundamentals remain reasonably sound: growth is solid, capital spending has momentum and consumer demand, though uneven, is far from weak. Yet external risks loom larger.</p><p>The biggest is the possibility of turmoil in global markets. Should Wall Street falter, India, consequently, would feel the drag through sentiment, liquidity and foreign flows. Interest-rate differentials between the US and India influence currency movements; a rise in American bond yields and a firmer dollar may prompt capital to exit emerging markets, pressure the rupee and tighten domestic financial conditions. Tariff skirmishes, policy unpredictability in the big economies and a jump in oil prices would, consequently, add further strain. A simple scenario framework helps clarify what to watch. In a benign global backdrop, India’s slightly elevated valuations are manageable, supported by domestic inflows, moderate inflation and reasonable earnings growth. Corrections in this setting are likely to be periodic rather than severe. In a more turbulent scenario – marked by rising US yields, a strong dollar, tighter global liquidity or a slowdown in global growth – Indian equities would find it harder to rely on domestic savers to cushion the blow. Corporate profits would need to broaden beyond a handful of leaders and new investments, especially in manufacturing and infrastructure, will play a pivotal role. Any wobble in these indicators would merit attention, as would a sustained rise in volatility or signs of stress in credit markets.</p><p>None of this suggests that India’s equity story is built on shaky foundations. Your columnist remains convinced that the long-term case for Indian equities is strong, underpinned by demographics, formalisation, digitalisation and a deepening capital market. But markets price the near term, not a distant horizon. Slight overvaluation, softer profits and an unpredictable global climate create a delicate balance. A sharp correction is not inevitable, but nor should investors assume immunity from global storms. The more useful exercise is not to forecast a fall, but to track the conditions under which one becomes more likely. For now, markets walk on air. They may continue to do so, until the winds beyond India’s shores decide otherwise.</p>
<p>Indian equities have spent much of this year trading toward the top of their recent range. The Sensex is not at a valuation record and price-to-earnings ratios in the low-twenties are broadly in line with what India has sustained for much of the past decade. Even so, indices have delivered handsome returns and the wobble earlier this year, when stocks shed more than a tenth of their value, has been quickly forgotten. The question now is less whether valuations are extreme and more what might cause them to adjust – and what signposts investors should watch over the next two or three years. Judged by long-term averages, Indian equities appear only slightly over the norm, but they are not cheap. A multiple in the low-twenties assumes that profits will grow steadily and that policy, liquidity and sentiment will remain supportive. Much depends, therefore, on the “E” in those ratios. Corporate profits, after the post-pandemic surge, have cooled. Earnings growth has narrowed, with much of the incremental profit coming from a small cluster of firms in telecoms, banking, autos and metals, while many others have reported flat or weakening results.</p><p>Another lens is volatility, often the most revealing gauge of market mood. India’s volatility index, derived from options prices, has in recent months hovered at subdued levels. In plain English, investors seem untroubled, hedging is inexpensive and risk appears scarce. Low volatility is not inherently ominous; yet when paired with relatively high valuations and slowing earnings, it can suggest that markets have become a touch too serene. A modest shock – a geopolitical flutter, stiffer global financial conditions or another quarter of underwhelming profits – may be enough to jolt sentiment. Gold’s occasional corrections and swings in the dollar offer further clues about global liquidity. If there are vulnerabilities, they lie increasingly outside India rather than within it. Domestic fundamentals remain reasonably sound: growth is solid, capital spending has momentum and consumer demand, though uneven, is far from weak. Yet external risks loom larger.</p><p>The biggest is the possibility of turmoil in global markets. Should Wall Street falter, India, consequently, would feel the drag through sentiment, liquidity and foreign flows. Interest-rate differentials between the US and India influence currency movements; a rise in American bond yields and a firmer dollar may prompt capital to exit emerging markets, pressure the rupee and tighten domestic financial conditions. Tariff skirmishes, policy unpredictability in the big economies and a jump in oil prices would, consequently, add further strain. A simple scenario framework helps clarify what to watch. In a benign global backdrop, India’s slightly elevated valuations are manageable, supported by domestic inflows, moderate inflation and reasonable earnings growth. Corrections in this setting are likely to be periodic rather than severe. In a more turbulent scenario – marked by rising US yields, a strong dollar, tighter global liquidity or a slowdown in global growth – Indian equities would find it harder to rely on domestic savers to cushion the blow. Corporate profits would need to broaden beyond a handful of leaders and new investments, especially in manufacturing and infrastructure, will play a pivotal role. Any wobble in these indicators would merit attention, as would a sustained rise in volatility or signs of stress in credit markets.</p><p>None of this suggests that India’s equity story is built on shaky foundations. Your columnist remains convinced that the long-term case for Indian equities is strong, underpinned by demographics, formalisation, digitalisation and a deepening capital market. But markets price the near term, not a distant horizon. Slight overvaluation, softer profits and an unpredictable global climate create a delicate balance. A sharp correction is not inevitable, but nor should investors assume immunity from global storms. The more useful exercise is not to forecast a fall, but to track the conditions under which one becomes more likely. For now, markets walk on air. They may continue to do so, until the winds beyond India’s shores decide otherwise.</p>
