Rs 72 lakh crore stock market boom flashes valuation warning. Where's the smart money going?

Time of India

01-07-2025

India's equity benchmark
Sensex
has rocketed an extraordinary 12,000 points in less than three months in a Rs 72 lakh crore rally, leaving cash-sitting investors nursing deep regrets as domestic and foreign money floods into stocks ahead of critical trigger points including Trump's July 9 tariff deadline and the looming Q1 earnings season.
The blistering 17% surge from April 7's low of 71,425 has propelled markets to near all-time high once again, with the Sensex and
Nifty
rallying for four consecutive months as domestic institutional investors splurged Rs 3.5 lakh crore while foreign institutional investors turned net buyers across all three months. During the period, the combined market capitalization of all BSE-listed stocks has soared by Rs 72 lakh crore to Rs 461 lakh crore.
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"We believe this is basically running on liquidity," warns Venkatesh Balasubramaniam of JM Financial Institutional Securities. "Domestic flows have been very strong with monthly SIP numbers over Rs 26,000 crore per month. Since March onwards, FII inflows have turned positive. Definitely this is running on flows." Besides, mutual funds have been sitting on large amounts of cash with May month's pile at Rs 2.17 lakh crore.
The relentless money flow has created a dangerous disconnect between valuations and fundamentals, with analysts cautioning that all market segments, large caps, mid caps, and small caps, are now trading at one standard deviation or more above their mean valuations.
Despite the euphoria, seasoned market watchers are sounding alarm bells about stretched valuations and the need for moderated expectations ahead of the tariff deadline and earnings season.
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"The first and foremost recommendation to investors is to moderate return expectations," cautions Nilesh Shah, MD of Kotak AMC. "Last five years returns are unlikely to be repeated in the next two to three years. Markets are fairly valued or a little bit over fairly valued, and re-rating is unlikely, which means returns will be linked with earnings growth likely in high single digit, low double digit."
Shah advocates diversification beyond equities: "Outside of equity, there are asset classes—REITs, InvITs, debt mutual funds, performing credit, AIFs, precious metals, index or ETFs. Please maintain your asset allocation across debt, equity, commodity, and real estate. Do not put everything in equity."
History, however, appears to favor continued gains entering July, with the month delivering positive returns in nine of the last 10 years and an average gain of 3.6%. Recent July performances include 2024's 3.92% return and 2023's 2.94% gain, reinforcing the month's bullish bias.
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Which sectors to invest in?
The Reserve Bank of India's aggressive monetary support through recent rate cuts and a surprise CRR reduction has turbocharged domestic liquidity, with financials emerging as the top beneficiary sector.
"Lower interest rates are helping banks and NBFCs. Credit growth remains strong, and asset quality is stable," notes Krishna Appala of Capitalmind PMS, highlighting financials as a constructive outlook area.
Karthick Jonagadla of Quantace Research sees particular opportunity in infrastructure financiers: "Lower policy rates and relaxed provisioning norms boost credit growth. PFC and REC leapt ~4% when the RBI's new rules landed, and PSU-bank indices hit six-month highs."
While capex and financials have led the recovery, Mihir Vora of TRUST Mutual Fund notes that "in financials, we have seen capital market plays doing well but banks and NBFCs have lagged" and could now start performing.
Technology stocks, which have lagged significantly year-to-date, are attracting contrarian interest as valuations turn attractive and fundamentals show signs of improvement.
"One can keep an eye on the IT sector which has not performed particularly well year-to-date," advises Atul Bhole of Kotak Mutual Fund. "After every major technology adoption, Indian vendors have actually experienced more volume of work. Large-caps are trading at relatively reasonable valuations and provide dividend yield support of 2-2.5%."
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The sector's appeal is enhanced by expectations of a normal business cycle returning, with Bhole noting that "assuming normal business cycle returning, IT spends can come back" as concerns over US economy and AI-led disruption may be overdone.
The chemical sector is attracting contrarian interest after enduring a brutal two-year downcycle, with early signs of price stabilization offering hope for revival.
"The persistent price fall of 2 years seems to be over and prices are stabilizing now. There are initial hopes for revival by companies," notes Bhole. "Companies are continuously investing behind products, client engagements and facilities. It may need some more patience, but provides a good opportunity to accumulate select chemical stocks."
However, export-oriented pharma and chemicals could face headwinds amid U.S. tariff uncertainty, requiring selective stock picking within the sector.
Several sectors that have lagged the broader rally are now showing signs of life as domestic demand improves and policy support continues.
"Consumer discretionary segments like automobiles (two-wheelers as well as four-wheelers), white goods have lagged and can now start performing," highlights Vora, noting improving rural demand and steady urban consumption.
Appala sees opportunity in consumption broadly: "Rural demand is improving, and urban consumption is steady. FMCG, two-wheelers, and discretionary segments are showing healthy trends."
In manufacturing and industrials, government capital expenditure remains high with the PLI scheme supporting domestic production. "Infrastructure and capital goods companies are seeing strong demand," notes Appala, with Jonagadla adding that "order books are overflowing—L&T reported a record ₹1 trillion intake in Q4 FY25."
While defence remains a compelling long-term theme, recent sharp rallies have made valuations prohibitive for fresh investments.
"We continue to like defence as a long-term theme. However, after a sharp rally and expensive valuations, we are cautious on adding fresh exposure at current levels," warns Appala.
As markets navigate Trump's July 9 tariff deadline and Q1 earnings season, the consensus points toward continued upside potential despite elevated valuations.
"While valuations are elevated in parts, the broader context remains supportive," argues Vora. "Earnings are coming through, liquidity is abundant, and policy remains growth-focused. The uptrend looks sustainable, though we do expect pockets of volatility."
The key for investors lies in selective positioning across financials, underperforming IT stocks, recovering chemicals, and domestic consumption plays while maintaining diversified portfolios as the liquidity-driven rally seeks fundamental validation.
(
Disclaimer
: Recommendations, suggestions, views and opinions given by the experts are their own. These do not represent the views of The Economic Times)