ETMarkets Smart Talk| India less vulnerable to US rate shocks, but expensive midcaps remain at risk: Amar K Ambani

Indian equities have become far more resilient to global rate shocks, thanks in large part to the strength of domestic liquidity. But that does not mean the market is immune to higher-for-longer US interest rates.

In fact, expensive pockets of the mid- and smallcap universe could remain particularly vulnerable if US Treasury yields rise sharply or earnings expectations weaken.

In an interaction with ETMarkets, Amar K Ambani, Executive Director at YES Securities, said India’s sensitivity to higher US rates is much lower than it was a decade ago, with strong domestic liquidity providing a cushion against global capital-flow volatility.


However, he cautioned that valuations remain a key vulnerability for mid- and smallcaps, leaving less room for disappointment in earnings or growth.

Ambani also highlighted the importance of understanding why US rates are rising. While higher yields accompanied by resilient economic growth may be manageable, a combination of sharply rising yields and weakening earnings expectations could create a more challenging environment for equities.

As markets navigate the US rate cycle, FII flows, domestic liquidity and stretched valuations, the key question for investors is whether India’s structural strengths can continue to offset global headwinds. Edited Excerpts –

Q) The headline story is interesting: Midcap and smallcap indices are at fresh record highs, but the broader market has been consolidating for weeks. Are we looking at a healthy rotation beneath the surface or growing complacency?

A) I would call it a healthy rotation beneath the surface, although some complacency has certainly crept in. What I find most intriguing is that even after almost two years of subdued market performance, several blue-chip large caps continue to disappoint.

This reality defies the conventional notion that large caps provide protection in difficult markets. Whether IT majors like TCS and Infosys, financial heavyweights like HDFC Bank, FMCG bigwigs like HUL, Dabur and ITC, niche spaces of life insurance, paints, and QSR, or marquee names like Tata group companies, RIL or Havells, all have seen substantial corrections, with many trading near or below their 52-week lows.

Of course, there are a host of underlying fundamental reasons that explain the lull. For one, large-cap earnings growth has been relatively weak. In the latest quarter, PAT growth for NSE 500 large caps hovered around 6.5% YoY, and merely 4.5% for non-financials.

Further, FII sell-off has disproportionately impacted large caps, retail participation has moderated, and a chunk of domestic institutional money has been pumped into the primary market. India is now increasingly being viewed as an “old economy” market, a perception that warrants some moderation in the premium multiples commanded by large caps.

In sharp contrast, the rotation towards midcaps and small caps has a fundamental underpinning. These segments delivered PAT growth of over 20% YoY, and the FIIs are relatively less active in them.

Midcap valuations versus large caps are now above one standard deviation. Quality midcaps and small caps will continue to deliver alpha, but selectivity will be key.

Q) The biggest risk with record highs is that investors confuse momentum with quality. Are we seeing that happen again in parts of the mid- and smallcap universe?

A) Yes, that might be happening in some pockets. But isn’t that a defining feature of every market rally? Whenever momentum builds, many investors inevitably chase performance ahead of quality.

It is imperative to make a clear distinction between identifying those with stock prices running ahead of their fundamentals, and those with earnings that credibly support the rally.

Q) Are we entering another phase where investors are buying anything that is remotely linked to capex, defence, manufacturing, power or AI?

A) That does happen every now and then. Once a theme catches fire, investors tend to buy anything remotely associated with it.

Mention “defence” and a drone stock becomes a hot favourite by default, and investors don’t even bother checking whether the company is assembling plain vanilla drones or making specialised micro-drones or those capable of carrying heavy payloads.

Having said that, at the broad sector level, I haven’t seen that kind of indiscriminate buying yet. Both capital goods and defence have had their share of outperformers and underperformers.

In fact, few defence stocks are down 15-20% over the last year. In power too, barring Adani Group stocks, most names have not moved meaningfully in last one year. AI is a limited direct play in India, but the theme can still have a say in the broader rally.

Q) Can domestic liquidity permanently offset sustained FII selling, or are we underestimating the influence foreign investors still have on valuations and sentiment?

A) Prior to 2014, the impact of FII selling was much more pronounced. Even $1 billion of selling could exert significant pressure on the Nifty.

Given the financialization of domestic savings and the growth of SIPs and domestic institutional flows, the market has become far more resilient to FII outflows.

We have seen intense FII selling following the AI-related sell-off and the US-Iran conflict, but our domestic liquidity has more or less cushioned the impact. Having said that, although FII selling may not lead to a severe market fall, it does impact market momentum and valuations. It is difficult for the market to sustain a strong uptrend amid a FII selling spree.

As they say, a stock needs a lot of buying to go up, but when sellers are in full force, the absence of buyers is enough to bring it down.

Q) The market is now watching the US Fed closely. How sensitive is India to the possibility that US rates may remain higher for longer?

A) India is certainly not immune to higher-for-longer US rates, but its sensitivity is much lower than what it was a decade ago. The sheer strength of domestic liquidity is a significant cushion against global capital-flow volatility.

More importantly, knowing the root cause behind higher US rates is crucial. If rates stay elevated following a steadily growing US economy, the impact on India is very different from a situation where rates are high owing to persistent inflation or fiscal concerns.

The current environment comes with stronger nominal growth, resilient consumption, and a structurally higher equilibrium real rate.

Markets are already pricing 2-3 Fed hikes over the next 12 months. I don't think that, by itself, warrants significant concern for Indian equities. A synchronised global rate cycle also reduces the risk of a sharp dollar-driven emerging market shock.

The bigger risk would be an unexpected change in the inflation growth equation, forcing the Fed to be restrictive for much longer than markets currently expect.

That could tighten global liquidity and make foreign investors more risk-averse towards emerging markets.

Q) US Treasury yields have been moving higher, and historically rising yields tend to trigger a risk-off sentiment by making safe US assets more attractive and tightening global liquidity. How serious a risk is this for Indian equities, particularly expensive mid- and small caps?

A) It is surely a risk, particularly for expensive mid- and small caps, but I would not call it a substantial risk at current yield levels. The key issue is what higher yields are accompanied by: deteriorating earnings or stronger growth.

The current environment is still supportive on that front. US corporate earnings expectations are strong despite higher yields, while credit spreads have been contained.

For Indian mid- and small caps, however, valuations are the bigger vulnerability. Elevated valuations leave less room for disappointment in earnings or growth. So, a rise in yields could trigger some de-rating even without a broader risk-off event.

I would hence watch yields and earnings together. A rise towards 5% is manageable if earnings remain strong. The real danger is sharp higher yields combined with weakening earnings expectations. A sustained move towards 6-7% would represent a materially different risk scenario for equities.

Q) The IPO pipeline is exploding. Are investors buying businesses—or just buying the hope of listing gains? What is your view on the upcoming NSE IPO?

A) Many IPOs undoubtedly bring high-quality businesses to the secondary market. Having said that, we must understand that there are different types of “IPO investors”. Some of them invest in every “good” issue with a long-term perspective, while others closely monitor grey-market premiums and apply primarily for listing gains.

The NSE IPO will be a fantastic addition to the secondary market. NSE earns fees on trades executed, without taking inventory or credit risk, and with relatively low working-capital requirement.

Its revenues are driven by market activity rather than capital deployed. Its strong competitive positioning also provides significant operating leverage.

Notably, NSE is much more than a trading-fee business. It earns from float money, index licensing, market data, analytics, listing fees, co-location etc.

Its Nifty franchise supports around Rs8.14 trillion of passive assets. In many ways, NSE is a proxy for India’s financialisation.

(Disclaimer: Recommendations, suggestions, views, and opinions given by experts are their own. These do not represent the views of the Economic Times)