I Believe in a Sustainable Recovery for the Indian Stock Market

You see, at the heart of the matter is the rise in commodity prices. This is eroding the healthy margins that companies enjoyed during the post-pandemic recovery.

Global supply chains are sensitive to geopolitics. The raw materials required to fuel industrial growth have become more expensive due to the war in the Middle East.

This has forced firms to choose between absorbing these costs or risking a drop in demand by passing them on to consumers.

Logistics costs have climbed steadily due to rising crude oil prices. International shipping routes have faced unprecedented disruptions. This acts as a silent tax on every physical good moved across the country, squeezing the bottom line of manufacturing and retail sectors.

Then there is a slowdown in project implementation. Execution delays are common. Companies are grappling with labour shortages, regulatory hurdles, and the complexity of large-scale infrastructure projects.

When a project stalls, the capital remains locked without generating a return, leading to a drag on quarterly earnings reports.

Furthermore, many businesses are finding themselves hitting a ceiling in terms of market penetration in urban India. The incremental cost of acquiring new customers in rural India is proving to be a challenge. Only time will tell which companies are equipped to handle this challenge.

All this was about the pressure on earnings. There is also the valuations angle.

The stagnant valuations (PE and PB ratios) of the market suggests the era of easy equity returns has temporarily concluded.

So this raises the obvious question: When will valuations expand again?

For the better part of this decade, a significant shift occurred in the Indian economic psyche. Household savings moved away from the traditional security of bank deposits toward the allure of the stock market.

This was hailed as a maturing of the domestic financial system. It seemed to create a deep pool of local capital that would shield the nation from the unpredictable ebbs and flows of FIIs.

The hope was that even if global investors withdrew their funds, the Indian retail investor would continue to invest.

However, the conflict in Iran has challenged this thesis. The geopolitical instability in the Middle East has introduced a risk that domestic savers will find difficult to ignore.

Evidence of this cooling sentiment is already visible in market data. For the first time since 2020, individual investors in India have shifted their stance. They become net sellers in the secondary market during FY26. This happened even before the war.

This behaviour indicates a fatigue among the retail investor base who are seeing their portfolio gains stagnate.

If the benchmark indices continue to hover around its current levels without a significant new catalyst, retail investors could find their portfolio returns to be unsatisfactory for the risk they have taken.

There are also external pressures on market valuations. The rupee has been the worst performer against the US dollar over the past year.

A weakening rupee makes Indian assets less attractive to FIIs. This is because any local gain is often cancelled out by the unfavourable exchange rate upon exit.

At the time of writing, a ceasefire has been announced in the conflict. If it does not hold, the flight of foreign capital will continue. Thus, the pressure on the valuations of Indian stocks will also continue.

This is particularly true for sectors that are currently perceived as fairly valued or expensive. Without the support of foreign inflows, these sectors are vulnerable to corrections if earnings do not meet the existing high expectations.

Conclusion

Despite my sober outlook, I believe a sustainable recovery will eventually happen.

The ongoing negative earnings impact and the stagnation of stock valuations can be viewed as a period of necessary detoxification.

By flushing out excess exuberance in stock prices and forcing companies to become more efficient, the market will build a resilient foundation for the next bull market.

This is the phase in the stock market that we at Equitymaster have seen before.

The flight of FIIs and the hesitation of domestic savers will create opportunities in fundamentally strong stocks that attracts long term value investors.

The geopolitical situation eventually stabilise. The impact of execution delays will be mitigated by the completion of long-term cycles.

That's when you can expect the earnings trajectory to pivot in the upward direction.

The recovery, when it arrives, will likely be driven by firms that have successfully navigated the high-cost environment and expanded their reach and capabilities.

Happy investing.

Warm regards,


Tanushree Banerjee
Editor, StockSelect
Quantum Information Services Private Limited (Research Analyst)