The two-engine problem: How valuation and earnings are pulling markets apart

Time of India

4 days ago

For the
markets
, June ended on an unmistakably optimistic note. With the Nifty just about 2% shy of its all-time high, chartists were quick to anticipate an imminent breakout. But now, well into July, in hindsight the market seemed to have played a clever trick— charming chartists with a breakout in the final days of June, only to stall and leave them grappling with what appears to be yet another false alarm.
As much as one would want to pin the blame on the chartists, it would be unfair to find fault with them. After all, the surge in momentum during late June—despite persistent headwinds ranging from global geopolitical tensions to erratic macro signals including tariff tantrums—gave every impression of strength. Deceptively, it was easy to believe we were on the cusp of the next leg of a bull run – particularly with the unexpected liquidity boost from the
RBI
and FIIs turning net buyers in June, adding fresh momentum.
But the real question: Even if the market breaks out,
Will the rally be sustainable, or just another short-lived surge?
That's the question on every seasoned investor's mind as they weigh the positives from the unexpected liquidity bonanza from RBI against the broader global uncertainties still looming large. Let us dive in and explore.
To understand this, let us look at the two key engines on which markets are run. One, the
valuation re-rating
and the other
earnings upgrade
. The first one has done more than its due part a long time back. Not much steam is left there as the markets are already trading at a huge premium to historical averages. If at all, there could be only downward adjustments. Given the robust macro in terms of falling twin deficits, rising reserves, moderating inflation and resilient currency in India, multiples are likely to sustain despite being at elevated levels without any major correction.
Now, let us look at the other engine which is corporate earnings. Do we have a cushion there? Is there a case for a big
earnings
upgrade? This is where the structural weakness in the economy creeps in.
Unfortunately, the key economic drivers are all stuck in low gear. Be it private consumption or private investment or net exports, all of them are struggling to move out of the range. Now, with renewed tariff uncertainties amid a downgrade in global growth outlook, it is unlikely that we will witness any meaningful breakouts in any of these except in consumption where RBI's liquidity might do its bit to pull it out of the current bearish range of sub-5% level where it seems to have got stuck because of the slump in income growth.
Take for example private investments – estimates show that the private investment as a percent of GDP has fallen to below 11% in FY25 from the level of 12.3% in FY23. When it crossed the 12% level in FY23, it gave a glimmer of hope that the private capex at last would turn the corner after being stuck at a sub-12% level for more than a decade. But that hope was short-lived as it fell to 11.2% in FY24 and further estimated to have slipped to sub-11% in FY25.
Now turning attention to private consumption, which constitutes over 60% of the GDP, it fell from a growth rate of 6.8% in the pre-covid era to 4.1% in FY20. After a brief recovery, it slid back into the slippery zone where it struggles around 5.5% in FY23. Here again, estimates are pointing to much lower levels in FY25.
With both private investments and consumption struggling, no prize for guessing that income growth will be the one that will be hit hardest. That is where payroll data spills the beans. As per that, net payroll additions under the employee provident fund were -5.1% in FY24 and -1.3% in FY25.
In summary, no hiding from the fact that the structural side of the economic story is on the slippery side, at least in the medium term though longer-term drivers continue to be intact.
As a result, we find ourselves in a contrasting market setup. On one hand, the macro environment remains strongly supportive, likely cushioning the market against any sharp correction. On the other, the absence of meaningful earnings upgrades amid already stretched valuations limits the case for a decisive breakout in the indices.
This suggests that the sideways spell is here to stay for a while, with the markets unlikely to break out of their current range in a sustained manner. That said, given the strength of both FII and domestic inflows, we can expect multiple breakout attempts. However, without a clear earnings catalyst, these are likely to prove to be false starts—brief surges
that fizzle out just as quickly as they began.
It doesn't mean that the side-ways markets are bad, especially for bottom-up stock pickers as the market trend will favor bottom fishing and value strategies compared to momentum strategy which was the rewarding strategy when the markets were on a one-way run last year. For those momentum days to come back, a long wait may be ahead. For now, it is time to settle for a sideways market, but not a stagnant one. Rejoicing times for bottom-up stock pickers!