Banking sector which has underperformed in the last two years, now offers a favorable risk-reward profile

Currently, the Nifty 50 is trading at a P/E of around 21 times one-year forward earnings, which is on the higher side. However, the market is not uniform in its valuations—different segments are trading at different levels. For instance, large-cap stocks are relatively less expensive compared to mid and small caps. Investors should focus on areas that either have the potential for positive earnings surprises, such as the pharma sector, or those that are attractively valued, like the banking sector.
In summary, this is a market where investors should concentrate on segments with a favorable risk-reward ratio and steer clear of those where overvaluation has reached extreme levels.
What is your near-term outlook of financial markets? Will the markets correct any time soon? By what percentage can we expect the market to correct in the near future?
Currently, market valuations appear expensive, but we don’t foresee a significant risk of a major correction for two reasons. First, the Indian macroeconomic indicators remain relatively strong, including factors such as the GDP growth rate, fiscal deficit, interest rates, inflation, and current account deficit. Therefore, these factors provide support to the current valuations, and any major correction would likely require a significant change in these metrics, which we don’t anticipate happening in the near term.
That said, at these valuation levels, we don’t expect further upward movement in valuations. As a result, market returns are likely to track the profit or earnings growth rate, which we estimate to be in the 10-15% range over the next 12 months. Consequently, we expect market returns to moderate from here, as additional valuation re-rating is unlikely. The returns will primarily reflect the earnings growth rate. Additionally, the risk-reward profile varies across sectors, with some offering better prospects than others, as I mentioned earlier.
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