A key concern for investors globally over the past few weeks has been the likely normalization of central bank's easy money policies and the consequent impact on economies especially Emerging Markets (EM). Consequently, FPIs had been pulling money out from EM which in turn have continued to underperform developed world equities through the year,said SBI Mutual Fund in its market outlook.

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Recent comments by Fed Chair however have acted to ease concerns a bit and FPIs appear to be looking at EM favorably again. Monetary policy in key developed markets may broadly stay accommodative considering the feedback loop into risk asset markets as well as to allow fiscal policy, the space to operate, the fund house mentioned.

"We, therefore, expect normalization to be very gradual and well signaled. While the risks from policy mistakes are non-trivial, the bigger worry in the near term stays the course of the virus and its impact on growth and inflation owing to continued, localized disruptions in several parts of the world," it said.

Amidst these worries, Indian equities continued with their strong performance with the Nifty and the Sensex rising 8.7 percent and 9.4 percent respectively in August. On a relative basis, Indian equities have stayed strong outperformer relative to Emerging Market equities leading to a significant expansion in their valuation premium, with the latter having struggled on account of a combination of factors including Fed taper fears, renewed growth concerns and Chinese regulatory clampdown on Tech companies over the past few months.

"Performance picture beyond large caps was not as rosy with the Nifty Midcap 150 gaining a more modest 2.1 percent and the Nifty Small Cap 250 declining 3 percent for the month. This was in sharp contrast to the trend of the past year or so wherein mid and small caps have significantly outperformed large caps. This reversal in relative performances was not completely surprising, however. We had highlighted last month that after the strong relative performance of mid-small caps versus large caps, their valuation differential had reverted to historical norms suggesting that the risk-reward was more balanced on that front now," SBI Mutual Fund said.

"On overall equity valuations as well, the sharp run-up has meant that even measures such as earnings yield relative to bond yields, attractiveness for equities has receded and a recovery in earnings is vital to support further upsides. And we continue to be constructive on corporate earnings. The strong prints on corporate earnings over the past few quarters at a time when economic growth is yet to find a footing suggests that the over a decade-long declining trend on the corporate profits to GDP ratio has been arrested," it said.

"At a time when economic growth has likely troughed, an uptick in profits to GDP could lead to a non-linear uptick in earnings over the next few years. Thus, the longer outlook stays constructive premised on our view that we are in the early stages of earnings upcycle, even as investors would do well to moderate their return expectations," it further stated.

"Key near-term risk continues to be a stretched reading on our equity market sentiment measure, but we would continue advising any significant pullbacks to add on to pro-economy assets," it added.

First Published:Sept 28, 2021 7:05 PM IST