Not GST Cuts, Not DII Pumps — Market Narrative Decided By Fundamentals, Says Kotak

Despite significant investments by domestic institutional investors in India's equity market's over the past 12 months, returns have remained largely flat. This, according to Kotak Institutional Equities, is a direct result of weak fundamentals rather than a lack of retail euphoria.

Kotak analysts Sanjeev Prasad, Anindya Bhowmik and Sunita Baldawa challenged the notion that large investment flows are the main driver of returns. Instead, the report argues, expensive valuations and earnings downgrades are to blame.

"Valuations have stayed at high levels, despite several stocks being flat or down over this period due to constant earnings downgrades. Earnings downgrades in several sectors and stocks over the past 12 months, which have kept valuations high," the analysts wrote in a note from Sept. 15.

The report says that domestic institutional investors have invested $90 billion in the secondary market over the past year, but the market has been largely flat. "This should dissuade institutional investors from focusing wholly or largely on retail flows into mutual funds as a driver of markets," it said.

The analysts added that despite several popular narratives emerging periodically — like earnings recovery, green-shoots of recovery in consumer demand, and even a shift in manufacturing to India due to the 'China+1' strategy — markets have remained stubbornly flat.

To add some context, the Nifty 50, Nifty Midcap 100, and Nifty Smallcap 100 indices have delivered returns of -1%, -2%, and -7% respectively over the past 12 months.

This has happened despite some relief that came in the budgetary announcement of income tax relief, recently announced GST rate cuts and even a monetary stimulus in the form of a 100-basis-point rate cut in the first first half of the 2025 calendar year.

The report also said that the sharp 5% depreciation in the Indian rupee should have aided some market earnings, but that never materialised. "The market’s performance would have been even worse with a stronger INR. The Indian market’s performance has been understandably worse in USD terms," the note said.

Kotak expects a gradual earnings improvement over the next few quarters and strong earnings growth in fiscal 2027. "However, valuations are rich, despite our strong expected earnings recovery."

The brokerage sees a recovery in earnings of banking and financial stocks after a weak first half of fiscal 2026. This is likely to play out on the back of a pick-up in loan growth and net interest margins, and a decline in credit costs.

The firm also expects a rebound in earnings of certain consumption sectors like automobiles due to GST cut-led volumes, which it said is likely to be offset by a moderate increase in earnings of the investment sector. A modest rise in earnings of the IT services sector is also something Kotak sees, given the continued weak demand environment.