We are in a typical VUCA (Volatile, Uncertain, Complex, Ambiguous) world. AI-led technological disruptions are impacting the world like never before. The long-term consequences of these technological disruptions will be profound. In the short-term, one man – the US president Donald Trump – is disrupting geopolitics and global trade in an unprecedented manner. Investors have to wade through this VUCA world cautiously. Investment decisions have to adjust to the evolving outlook, which is fast changing.
Global economy is slowing down
Global GDP grew at 3.3 percent in 2024. The projection by IMF for 2025 is 3.1 percent. The two large economies of the world – the US and China – are likely to slowdown in H2 2025. Global trade has been subject to short-term shock by the unprecedented tariff tantrums of President Trump. In response to the slowing economy, the central banks except those of Brazil and Japan, are easing policy rates.
Stagflation in the US?
An increasing number of economists now believe that the US might tip into a short period of stagflation. President Trump’s tariffs ranging from 10 to 35 percent has come into effect. High tariff of 50 percent is being threatened on countries like India. The average tariff on imports to the US is about 18 percent. A significant part of these high tariffs will be passed over into the prices of goods, pushing up inflation in the US. The coming months are likely to witness creeping inflation in the slowing US economy. This will put the Fed in a tight spot and in a possible clash with the mercurial President Trump. This evolving scenario needs to be closely watched.
Massive policy stimulus in India
The Indian economy, the fastest growing large economy in the world during the last five years, has slowed down a bit. India’s GDP grew by 6.5 percent in FY25. In the context of the convulsions in international trade and the high tariffs imposed on India, the growth target of 6.5 percent for FY26 may not be achieved. Around 6.2 percent growth for FY26 appears to be a more realistic growth target.
During the last five years, the public capex has been doing the heavy lifting for growth. Private capex has been slack constrained by weak demand and looming uncertainty triggered by volatile geopolitical developments. Capacity utilization has been stuck at around 75 percent for a long time.
The Government and the Central Bank have been very proactive in policy decisions. The year began with a massive fiscal stimulus with a bold Budget which gave unexpected big relief to income taxpayers by exempting annual income up to Rs 12 lakhs (Rs 12.75 lakhs for salaried employees) from income tax. This fiscal stimulus was complemented by a strong monetary stimulus with the Monetary Policy Committee (MPC) cutting policy rates by a cumulative 100 bp and a calibrated reduction in Cash Reserve Ratio (CRR). CPI inflation in India has been steadily coming down (1.55 percent in July) enabling, perhaps, one more rate cut by the MPC soon.
Reforms appear to be in a fast-forward mode. In the Independence Day address, the prime minister declared a thorough overhaul and simplification of the GST regime by Diwali. It is expected that the GST council will reach a consensus on broadly two GST slabs of 5 percent and 18 percent for most goods while retaining the 40 percent slab for the ‘sin goods.’ This simplified GST regime will have positive consequences through increasing compliance and efficiency gains. More important, GST reduction will lower the prices of many goods thereby boosting their demand and stimulating economic growth. The beneficial effects of these policy initiatives are expected to kick-in starting with the festival season.
Expect moderate returns
The bull run of the last five years delivered excellent returns to investors. During the five-year period ranging from 5th January 2020 to 31st July 2025, the BSE 500 delivered 16.9 percent return. The mid and small caps outperformed with 23 to 25 percent return. These high returns delivered by the mid and small caps have been attracting sustained money flows into these segments, pushing their valuations into unjustifiable territory.
Beware of valuations
In the short run, the market can turn irrational and continue to remain irrational for some time. But, in the long run, valuations will revert to the mean. This is the lesson from history. Therefore, investors have to give due weightage to valuations in their investment decisions. Nifty at 24,500 is trading at a PE of about 21 – one of the highest valuations in the world. Out of the BSE 500 stocks, 215 are trading at a PE above 50. High valuations are prompting FIIs to sell in India and move money to cheaper markets. So far in 2025, FIIs have sold equity for $13 billion. It can be argued that given India’s long-term bright growth prospects, large cap valuations, though higher than historical averages, are justified. The mid cap segment has a strong tailwind of growth, partly justifying the valuations. But small caps are excessively valued. Therefore, investors have to be cautious in investing in the overvalued segment.
