Indian stock market has found its magic…!

The current domestic rally stands on solid ground, with the Sensex potentially set to breach the 80,000 mark. This surge began with the formation of a stable coalition government, which instilled confidence among investors. Since June 4, the key indices have climbed 10%, significantly reducing the country's risk profile by reversing net outflows (QTD) from FIIs.

The India VIX index, which peaked at 26.75 on June 4, has since halved to 13.8, indicating a significant reduction in market volatility. This positive trend has particularly benefited heavyweight sectors such as finance and consumer goods, in which FIIs have regained interest after several months of net selling in April and May.

This rally in the market is also driven by positive expectations for the upcoming budget. There is growing optimism that the newly formed government, committed to pro-growth policies, will take this agenda forward through a number of measures in the coming financial year.

At the same time, the government is expected to strike a balance between growth and populist gains. These initiatives are crucial to boost prosperity, especially among the rural and lower-middle class population, given the growing income gap and changing public sentiments.

This week, the overall market momentum has shown signs of moderation, with consolidation especially in mid- and small-cap stocks due to their premium valuations. Since June 4, large caps have gained 10% while the broader market has gained 11%, indicating a lack of outperformance of mid and small caps.

This underperformance could continue in the short term following the strong performance of the broader market YTD, which is up 16% compared to the Nifty 50's 8%. Profit booking is also emerging due to concerns about slow progress of monsoon and heatwave in north India impacting short-term demand, though we believe this is a transitory issue.

In this peak phase of the market, there is a clear sectoral shift from high-priced stocks to value stocks. Fresh buying is being seen in private banks, telecom, IT and consumer durables. This week, finance-led rally is being seen, while profit booking is clearly seen in realty, power, metals and midcaps.

On the global front, sentiment has improved as the possibility of a rate cut by the BoE in August has increased. Similarly, in the US, unemployment claims have risen, and weak housing data has raised expectations of a rate cut in September. Domestically, sectors such as textiles, fertilisers and banking are expected to see GST rate rationalisation in the BoE, which is scheduled to meet in August. This is expected to boost sector-specific growth in the near term.

The inclusion of Indian bonds in the JP Morgan EM Bond Index is a meaningful development for the Indian economy, with long-term implications. While its direct impact on the stock market may be limited, this development strengthens the domestic economy and the local currency.

This is expected to reduce rates in the medium term, reduce the discount rate or country risk and improve the earnings outlook in the long term, which is positive for equities. This is also expected to reduce inflation by either a slight increase or a reduction in the rate of INR depreciation. This will reduce the cost of imports and lead to faster-than-expected rate cuts by the RBI in the medium term.

To summarise, recent developments over the last month have been largely favourable. The only concern is high valuations in anticipation of low to teen earnings growth in FY25 and FY26, which will limit super returns in the short term.

Well, earnings growth is at risk due to the improvement in GDP growth forecast, as indicated by the RBI in its June policy, which is likely to lead to further improvement in earnings in the coming quarters. Overall, the stock market is currently performing strongly without any obvious negative factors hampering its progress. Notably, India has started to outperform the rest of the world, which was lagging YTD.

The author is Vinod Nair, Head of Research, Geojit Financial Services.

Disclaimer: The views and recommendations expressed above are those of individual analysts, experts and broking companies and not Mint. We advise investors to check with certified experts before making any investment decisions.

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