Fund Manager Talk | Defence stocks rally shows FOMO taking over rationality, says Kotak's Atul Bhole

The recent ferocious rally in defence stocks post the recent skirmish is yet another example of greed or FOMO taking over the rational investing behavior, says Atul Bhole, EVP & Fund Manager, Kotak Mahindra Asset Management Company.

"Since Operation Sindoor, defence stocks bounced back significantly and are again trading at much higher valuations than can be justified by fundamentals. While companies could deliver sustainable growth over many years, the street seemed to have factored in a lot, in a very short period. Hence there can be some cooling-off or longer consolidation in stock prices," he said in a chat with ET Markets.

Edited excerpts:

Markets are dancing near lifetime highs. How much of this is driven by fundamentals and how much by FOMO?
India’s macro fundamentals are in a really sweet spot & proving to be one of the strongest versus major global economies. Tightly controlled fiscal & current account deficits, lower inflation & stable currency while maintaining growth handle around 6-6.5% are attracting back foreign flows in a major way. While the macro fundamentals have been stronger for quite some time, the resilience & the sweet spot became more apparent during the current global trade war. While from the start of the year to mid-April, FIIs sold close to $15 bn, from mid-April the flows turned positive and since then FIIs bought around $5.5 billion of Indian equities. This buying, too, is happening largely from the secondary market than IPOs/QIPS or direct stake sales. Domestic flows have actually been very reasonable in activity with cash levels in mutual funds rising & retail participation also been in check vs. the recent past. While corporate earnings growth is still muted & valuations on the higher side, the strong macro fundamentals are directing robust foreign as well as domestic flows to Indian equity markets.

What's your reading of retail investor behaviour right now? Have most of them learnt lessons after playing with fire by chasing SME and momentum-heavy smallcaps?
Some SMID stocks had seen value erosion of 40-60% during June-July’24 to Mar-Apr’25 period. These stocks were in momentum with false support of narratives, illiquidity & greed/FOMO & were devoid of fundamentals or valuations. Institutional investors like mutual funds which invest with research & expert insights could avoid such pitfalls & protect the level of drawdowns. Few investors would have definitely learnt lessons in this episode & hopefully start appreciating the value mutual funds/advisors add in long-term wealth creation. However, the market is like a voting machine in the short term & keeps attracting new investors or making the same investors repeat newer mistakes. The recent ferocious rally in defence stocks post the recent skirmish is yet another example of greed or FOMO taking over the rational investing behaviour.

Operation Sindoor has also worked like an international defence expo showcasing the might of Indian defence companies. This is also reflected in the dramatic movement in share prices. How strong is the defence story on Dalal Street?
Indian defence equipment industry has gathered robust momentum in the past 3-5 years with strong indigenisation push by the Government as well as bigger & expedited orders. The eco-system is getting developed nicely with private sector companies emerging as credible component manufacturers. The stocks did extremely well post-Covid till mid of 2024 on these policy enablers & effective implementation. However, more than the earnings growth, valuation multiple or PE re-rating was the bigger driver of stock returns. From an average of 10-20x PE, these stocks went on to trade at 50-60x PE. As mentioned above, from mid of 2024 to Mar’2025, some stocks experienced 40-60% drawdown from extremely over-stretched levels. Since Operation Sindoor, defence stocks bounced back significantly and are again trading at much higher valuations than can be justified by fundamentals. While companies could deliver sustainable growth over many years, the street seemed to have factored in a lot, in a very short period. Hence there can be some cooling-off or longer consolidation in stock prices.

With valuations stretched in certain pockets of the market, do you think the Q4 earnings season was strong enough to justify the rally that we are seeing?
Q4 earning season is turning out to be muted yet again in absolute terms, with 5-10% earnings growth depending on sectors or large cap/SMID etc. Market is not overtly disappointed as expectations were already lowered post 3 quarters of continuous low-growth & weak corporate commentaries. Markets are forward-looking and though Q4 is not up-to-the mark, going forward earnings are expected to pick-up with tax breaks, in-line monsoons, better wage & salary increases, continued capex etc & particularly with the help of low base. The current rally is largely driven by strong macro fundamentals & subsequent flows; the market may take a pause till corporate India starts to deliver better earnings growth.

As an investor today, would you back consumption, capex, or financials in FY26?
Post-covid all sectors or themes had experienced rallies for particular duration of time & are trading at fair to high valuations at present. The triggers which worked on those sectors at that particular point of time had also played out well. As things keep normalising, we believe, returns would be driven by individual stock selection across sectors depending on earning triggers & valuations. At the sub-sector level, we like quick commerce, hospitals, power T&D, EMS, larger Pvt banks & NBFCs etc from the domestic side of the economy. As a contrarian investment, the IT sector can be evaluated with US corporates holding up better than expected & good dividend yield support for the stocks.

Given current earnings momentum, macro tailwinds, and political stability bets, is Nifty 30,000 a realistic target by end of FY26?
While at the macro level, most of the things are moving in the right direction for India, it has to start reflecting in corporate profitability as well. Post the recent rally, Indian markets are again trading at 21-22x PE on a 1-year forward basis. These multiples require earnings to grow at a much better rate than the current pace. While it can pick-up with better disposable income growth, continued capex & reforms etc. global trade war & global growth remains bigger variables. India appears to be in a better situation as of now, but larger economic blocks like China & Europe can start attracting large amounts of capital depending on tariff negotiations & changing fiscal / monetary policies given relative valuations advantage. US fiscal position & dollar valuation would also impact flows & hence asset prices.

Investors have been caught between two battlefronts lately — the global trade tariff war and the near war-like tensions between India and Pakistan. Now that both seem to be easing, what are the key takeaways for investors from this double dose of geopolitical anxiety?
Over a longer period, stock prices & markets are slaves of earning growth. In shorter terms, there can be under or over valuations depending on news flows & sentiments. In the past 5 years, we have probably experienced things which typically happen in a decade or century perhaps. Covid pandemic, wars, supply chain obstacles, outlandish progress in computing power & adoption of AI or the strategies of the mightiest sovereign (the USA) to get its balance sheet in shape etc. events have just happened or are still taking place. Markets continued & evolved in their journey throughout. Investors obviously need to adapt to new realities while keeping the hat of age-old investing principles intact. Studying or looking at history (of markets) over a longer period can help us manage behaviour in a much better way. Patience, systematic investing & exploiting episodes of greed & fear to our advantage helps in achieving the investing goals.