Can Indian markets sustain their rise despite high valuations and global uncertainties?

Mumbai: Amid the din over foreign selling, Donald Trump's economic broadsides and slowing growth, one detail seems to have slipped under the radar: the Sensex and Nifty are just around 4% shy of record highs. The recent climb hasn't been dramatic-September has brought small, steady gains rather than fireworks, while the Volatility Index, or VIX, has sunk to a record low of 9.89, showing how calm traders seem to be about risk. And yet, there's little sign of euphoria. Investors are stuck with the paradox: valuations look stretched, the risk-reward trade-off feels poor, and still prices keep inching higher.

This would not be the first time India's equity market wrong-footed sceptics and critics. Seasoned investors have warned repeatedly over the past year that indices are stretched, pointing to elevated valuations and slowing growth. Yet, share prices have continued to hold up and even edge upwards.

It is a familiar paradox
When investors are positioned conservatively, even scraps of moderate good news can set off rallies because there's hardly any selling to cap the move. In September, that is what is playing out. Receding foreign selling along with the structural weight of monthly flows into equity mutual funds from domestic savers has ensured a constant bid up for stocks.

The result has been benchmarks edging higher in a steady, unspectacular fashion. It may also explain why the recent upmoves have gone largely unnoticed among Dalal Street participants, who often associate breaking records and milestones with full-blown rallies.

If foreign selling merely abates rather than reverses, the weight of domestic liquidity could drive benchmarks another 10% to 15%, say money managers. Large-cap stocks are best placed to lead such a push.

That said, any breakout will face its own tests. Donald Trump has continued to target India on trade and immigration, with the latest move hitting H-1B visas. The eventual impact on IT services demand will be felt, and technology is one of the two pillars of the Sensex and Nifty, the other being banks. Foreign investors have already offloaded IT shares worth about ₹62,000 crore so far this year-the heaviest sectoral selling. That creates an overhang even as valuations in the sector adjust.

Liquidity vs valuations

As liquidity takes precedence, this market may be better suited for the nimble-footed. Meanwhile, conservative voices often get trapped by focusing on headline valuations or macro risks, underestimating the power of liquidity and missing out on late, yet sharp, rallies.

As Michael Lebowitz, portfolio manager, Real Investment Advice, said on VettaFi: "In the long term, high valuations often predict poor returns. However, in the short term, expensive valuations can become even more expensive."

In India, even as liquidity keeps markets afloat, nagging concerns over valuations continue to linger. The country's nominal GDP growth has slowed to 8-9% from 11-12% in earlier years, and equity return expectations have moderated accordingly. This mismatch between growth and price explains why long-term foreign capital has flowed into cheaper markets such as China.

This tension means that while short-term flows may support Indian equities, long-term allocations from global investors are likely to be more measured. That's the thing with high valuations: they do not cause an immediate fall, but they do make the risk-reward look tricky and the rally harder to trust.

Paradoxical as it may sound, record valuations do not mean markets would not rise further immediately. The catch is, lofty valuations almost always mean thinner returns over the long haul. The investors who manage to live with that ambiguity are the ones who keep their portfolios ticking. And, they are often in the minority.

Gold vs Equities
In the meantime, many seasoned investors have found a better way of keeping their portfolios moving without having the guilt of buying costly equities: Gold. The reassessment of risk is evident well beyond India. Morgan Stanley's chief investment officer Mike Wilson recently suggested a 60:20:20 portfolio split: 60% equities, 20% bonds and 20% gold. It marks a sharp departure from the classic 60:40 model (equities-bonds) that has dominated investing for decades.

A 20% allocation to gold is unusually high for portfolios and would show how investors have become wary of relying on equities alone to generate inflation-beating returns.

The irony of any sharp upmove in equities is that it will be met not with celebration, but with a mix of scepticism and the nagging fear of having missed out. It is also a reminder that markets often rise on hesitation, leaving equity enthusiasts unsure whether to cheer the highs or worry about what could be in store after that.