Sharma expects the market returns to remain unimpressive after five years of a bull run due to a slowdown in government capex and single-digit nominal economic growth, which translate into muted earnings growth. What determines market direction in the ultimate reckoning are earnings, not flows alone, says Sharma, referring to foreign portfolio investors turning buyers after six and a half months of sustained selling in the secondary markets. Edited excerpts:
You have said that markets tire after the fifth year of a bull run, but now flows seem to be improving again despite tepid results. Your take?
Contrary to what people are led to believe by the marketing hype around equities, the inescapable truth of markets is that they are cyclical by nature. There is nothing called a permanently uptrending bull market.
Even in India, history tells us that we have not had bull markets longer than 4 years, and 5 years at the most. That is exactly where my ‘Lake of Returns’ theory comes in.
Returns from stock markets and, for that matter, any asset class are finite. Like the capacity of a lake, returns from the stock market are not like a permanently flowing river. Therefore, the lake levels can rise dramatically in a bull market, and then these supernormal returns cause a breaching of the safety levels of the lake and distance into a calamity of flooding. It is by this natural and repeatable process that the lake levels dry out to a level of abysmal returns.
The bull market that started in April 2020 had already entered its fifth year in 2025, and it is usually around this time that the bull starts to get extremely weak.
And then you have seen, in the last few months, a very precipitous fall in the broad market. Small-caps, which were the leaders in the bull market, were crushed with the average small-cap stock falling 50% and more.
From those beaten-down levels witnessed in January and February, it is inevitable that markets would stage a pullback rally and that is exactly where you are right now in the cycle.
No bear market is ever permanently down-trending. They have sharp rebound rallies and, most of the time, those rallies do not sustain.
But the fact remains that these rallies are given the colour and narrative of the resumption of a bull market, and various pieces of supporting logic are offered up. Foreign portfolio investor (FPI) flows turning positive is one such supporting logic.
However, again the data on such flows predicting and determining the future direction of the market is extremely poor and there is just no way where you can make a prediction about markets based on flows in the market.
Ultimately, what drives markets is earnings and, as you point out, they have been very sombre so far this quarter, and the outlook for the year is also not very encouraging.
India is a major economy to enjoy upwards of 6%, which, at a time of slow global growth due to tariff concerns, seems to put us in a better spot than others.
You’re absolutely correct. But whether that is good enough to propel the markets to another bull run is the key question. And embedded in this question is the fact that more than real GDP growth what you have to look at is the nominal GDP growth projection, and that is in single digits.
Corporate profits are simply a reflection of nominal GDP growth, not of real GDP growth, and there are a lot of headwinds on GDP growth itself.
One of the biggest headwinds to GDP growth is the fact that our central government fiscal position has become overly dependent on stock market-related taxes; and given the state of the markets, it is highly unlikely that we are going to see capital gains taxes and securities transaction taxes reaching the previous-year levels.
A shortfall on these accounts is almost a given and how the government makes up for it is going to be a key question.
There is a fairly good chance that the government capital expenditure budget might actually not be met and might be lower, and this absolutely will have a direct impact on our growth figures.
Markets are all about being realistic and practical and at this moment, equity markets in India do not have a great outlook on a top-down basis given a variety of factors.
FPIs, retail and high-net-worth investors didn’t seem overly worried about the Indo-Pak tensions. FPIs have instead been buying India since the second half of April. What to your mind has brought about this and will it endure?
We get overly excited about buying and selling, while in reality for every buyer their has to be an seller and for every seller their may be a buyer!
Therefore, if foreigners are buying then somebody has to sell to them for the transaction to happen and the net impact of somebody’s purchases in the stock market is always zero because buying always equals selling.
There is simply no lasting impact of anybody’s buying in the market barring short-term immediate impact seen on stock prices, but these effects are temporary and transient.
The foreigners were selling at the peaks to Indian retail and now with the markets having fallen they are buying. That is usually the way smart money works.
However, whether this means another big strong bull market is not a straight-forward answer.
The weakness in the US dollar is driving money into emerging markets, and India is getting part of those flows. But that will not necessarily change the direction of the market itself because, as I have pointed out many a time, somebody buying or somebody selling has no lasting impact on the direction of the markets.
Which sectors do you like here and why?
I have liked fixed income and gold. One does not have to permanently like equities. At least, I believe in looking at opportunities across the broad spectrum of investable assets.
Within Indian equities, I still continue to be very bullish on small-caps but extremely selectively. I know several companies that have very promising growth outlooks for this year and I am continuing to invest in those, but with a less aggressive frame of mind then I would have had three years ago.
Because remember that everything is going to perform in line with the macro moves of the market, and if the macro move in the small-cap index is weak, then most of the stocks will also remain weak and there will be only a handful of exceptions.
We’ve enjoyed 25%-odd annualized returns in the past five years through 2024. What’s your expectation for 2025 and 2026?
My return expectations for the coming few years is that India will deliver below-trend returns and this means that investors need to be looking outside of equity to keep their heads above the water.
However, the marketing around equity investing in India is just the very best marketing I have seen in any product in the history of the world. And that is simply because there is money to be made in promoting equities, while there is zero money to be made in promoting fixed income or gold.
But the fact remains that for the times to come, other asset classes look far more promising than equities in India.
Of course, as a professional investor, one is able to get opportunities that an average investor cannot get and that is the reality of the market–that it is not a level-playing field.
Post the conflict with Pakistan, defence stocks have come to the limelight again. Your view?
I am, in general, very bullish on global defence as a sector play and I have been long this sector for the last four years. I did not buy Indian defence companies in the previous frenzy but I have several global ones. However, I do see a significant order inflow for good Indian defence companies in the coming years because now there is absolutely no choice for India but to increase defence spending significantly.
However, this is like a seesaw: increased defence spending will have to be matched by cuts somewhere else and that somewhere else is most likely going to be government capex. Broadly speaking, the pie chart of the budget will see an increase in defence and decrease in capex over the coming years.
We are in a low-interest-rate cycle with the rupee having appreciated from its lows earlier this month. Don’t you think this will help corporates?
Yes, it will definitely help corporates, but also remember that Indian corporates in the last decade have reduced their borrowings down to very, very low levels; so a decrease in interest rates does not really impact most of the large companies in India that dramatically as it might have done 20 years ago.
What’s your view on private capex?
This is an impossible dream, and again, I am a person solely based on numbers and data, not stories.
It is a nice little story and fairytale that is peddled by all and sundry. But if you simply look at the data, you will know very quickly that there is no way private capex in India that can move the needle.
Out of the total profits of Corporate India, which might be perhaps around $100-120 billion at most, manufacturing profits are only around 25% of this: that is, $25 billion or so.
Capital expenditure is done only by manufacturing companies and not by services companies. And India is a primarily services economy and the stock market reflects this composition.
If you have only around 25 billion US dollars coming by way of manufacturing profits in India, capital expenditure will be a subset of this figure. You can say maybe around 15 billion dollars.
But remember that capital expenditure by companies is not an annual affair. They are done once every few years, so this $15 billion capex is what you will see spread over several years and not every year!
The government’s capex is something like $120 billion. You can see the scale of difference between the two capital expenditures.
There is no way on earth that private sector capital expenditure in India can even remotely move the needle and approach government capex.
And the other big problem is that the stock markets in India do not reward companies that are investing a lot in capital expenditure because they reward companies that are asset-light. And that is exactly the core problem that we have in India: the stock market discourages capex.
China does not have a vibrant stock market like India and that has actually helped that country become a manufacturing giant because manufacturing requires capital expenditure, and the stock market discourages capital expenditure.
The stock market in India itself is the core problem for India, from a capital expenditure perspective.
The government has reduced taxes for those earning a salaried income. Would this boost consumption?
This is an excellent step by the government.
However, the amount is only around $2 billion and that comes to only 0.3% of GDP. It is not even worth discussing what the impact will be because the impact is literally zero on the broad economy, even though it will help the people who have got this benefit.
If you had ₹100 now, how would you allocate it?
Indian equities: 30%
Fixed income: 50%
Gold, silver: 20%.
We have a few good things in our favour like lower interest rates because of lower crude and a stronger dollar, but that does not mean that we should be aggressively piling into equity like we could four years ago. This is a difficult pitch now and not a 500-run pitch.
Trying to play an aggressive game on this kind of pitch is a recipe for disaster.
This is the time when you do not want to lose wickets and if you do not lose wickets, the runs will come.
Investing is exactly like playing test cricket when you place yourself depending on what the conditions are, because the conditions are not going to change to suit your kind of play; you have to change your play to suit the conditions.
