Equity Exposures: Assessing the Case for Increased Allocation

Indian Equity Markets Decline Amid US-Iran Conflict, Offer Favourable Window for Investors

The Indian equity markets experienced a decline of more than 11% in March, largely due to the prolonged US-Iran conflict, which pushed crude oil prices higher and intensified inflation concerns. However, a recent report by DSP suggests that the recent correction in Indian equities may be creating a favourable window for investors to gradually increase their exposure.

The report noted that valuations have cooled meaningfully, particularly in large-cap stocks, bringing them closer to long-term averages. The Nifty's price-to-earnings ratio has fallen below 20x and is nearing its historical average, making incremental allocation more attractive. DSP stated that with the current correction, the market now sits between fair and average valuation zones, making incremental allocation more attractive.

A disciplined approach is key during such phases, as falling markets allow investors to accumulate more units at better prices. The report emphasized that valuations across key sectors such as banks, IT, healthcare, and parts of FMCG are now at or below long-term averages, strengthening the case for increasing exposure.

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The report highlighted that starting to raise equity weights during corrections, rather than waiting for clarity, has historically proven more effective. The Indian stock market ended with strong gains on Tuesday, April 21, following mixed global market cues, as investors increased risk appetite as they were optimistic about the US-Iran peace talks.

The Sensex climbed by 753 points, or 0.96%, finishing at 79,273.33, while the Nifty 50 wrapped up with a solid increase of 212 points, or 0.87%, at 24,576.60. US Vice President JD Vance will travel to Pakistan on Tuesday for Iran talks, reports said. Tehran's own negotiators received a last-minute green light from Iran's supreme leader to attend the talks, Axios reported.

DSP highlighted that several market indicators are aligning in favour of equities, including oversold technical readings, elevated volatility levels, and weak market breadth—all of which are typically seen during phases of panic selling. The report noted that only a small proportion of stocks are trading above their key moving averages, suggesting widespread correction and potential opportunity for long-term investors.

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Importantly, the report pointed out that the gap between bond yields and earnings yields has narrowed to around 1%, which it described as an attractive zone for owning equities. DSP added that such conditions have historically been seen during periods of heightened pessimism, often preceding better forward returns.

The report also highlighted a behavioural challenge for investors, stating that the real challenge for investors is behavioural, not analytical. When sentiment is weak and narratives are unfavorable, acting on opportunity becomes inherently difficult. DSP further noted that large-cap stocks appear particularly attractive at current levels, with valuations of top companies near multi-year lows and offering strong return on equity profiles.

At the same time, it advised caution in small and mid-cap segments, suggesting that allocations in these areas should be done selectively through active strategies and systematic investment approaches.