Systematic Investment Plans (SIPs) seem to have put Indian stock prices in limbo.
In recent years, the substantial influx of capital from retail investors has been a significant factor driving the movement of Indian stock prices. Most of this money was channelled through mutual funds, principally through SIPs. SIP flows are continuous fund flows from investors based on a decision made earlier. Once you commit to a SIP, money is automatically transferred from your bank account to the stock market periodically. Changing market conditions don’t alter your monthly SIP commitments. Neither does changing investor sentiments. SIP fund flows have provided the necessary stability to the markets, particularly over the past eight months, when significant uncertainty prevailed.
Investors’ enthusiasm for SIPs has led to the more than doubling of mutual funds’ total assets under management over the past five years. The increased investor interest in SIPs was for the right reasons. Stocks have rewarded investors handsomely over the past five years, and as always, investors mistakenly assume those handsome returns will continue in the future. The assumption has caused them to double down on their equity investments. The assumption is mistaken because future market performance has negligible correlation with past or present performance.
Extremely low interest rates globally, combined with massive stimulus measures following the COVID-19 pandemic, were primarily responsible for the superior stock returns. However, those causes no longer exist. The stimulus measures have expired, and interest rates have risen to above-normal levels. However, the continued strong domestic fund flows into markets, mainly through SIPs, indicate that investors haven’t yet woken up to the changed reality.
Today, valuation remains elevated for Indian stocks. Strong SIP flows in the past might have partly contributed towards today’s higher valuation. Moreover, the continued strong SIP fund flows might be sustaining the elevated valuation. However, it won’t take much time to puncture the investor enthusiasm driving the strong SIP fund flows into the market.
On several previous occasions when markets had run far ahead of fundamentals, an exogenous event – a catalyst – has unexpectedly arrived and disrupted the unsustainable trend. Most of the time, regulators inadvertently trigger the event by tightening rules to restrict an unsustainable trend from becoming a significant risk to the economic system. Today, the consensus expects and demands that interest rates be reduced. But if interest rates had to be hiked for some unforeseen reasons, that could likely act as an exogenous shock.
However, stocks could also suffer without an exogenous shock. If stock prices fail to deliver returns as expected for an extended period, it could dampen investor interest in the stock market. The dampened interest could bring an end to the SIP mania in the Indian stock market. The resultant drought of domestic fund flows could put significant downside pressure on stock prices.
Lower returns from traditional sources, such as bank deposits, were also a reason for the increased embrace of equities. Investors make decisions based on an evaluation of the relative merits of different asset classes. The equity preference trend began as investors shifted money from fixed-income investments to equities due to the lower returns from the former and the better returns from the latter. Similarly, in the future, investors may be prompted to seek alternatives to equities if they continue to deliver lower returns. If such an alternative asset class were to emerge, investors would likely move money away from equities to the alternative, resulting in compressed equity valuations – an unpromising scenario for equity investors.
Return doesn’t have to be the only criterion for the choice of an asset; risk can also be a criterion, sometimes. Equities are risky assets. Continued lower returns may cause investors to shift money from equities to lower-risk assets, despite the absence of any significant return benefits.
Although the Indian market has delivered double-digit returns over the past five years, it has remained mostly unchanged and significantly volatile over the last year. Nifty50 trades at around 24,500 today. It first reached this level more than a year ago, in July 2024. Between then and now, it rose to 26,000 in September 2024, declined to 22,000 by March 2025, sharply recovered to 25,500 by July 2025, before falling to 24,500.
There is too much uncertainty, both domestically and globally. The uncertainty has caused decision paralysis among major decision-makers, which includes regulators, government authorities, business owners, investors, and consumers. Most of the blame for the uncertainty is attributed to the Trump administration, due to its belligerent trade, tariff, and immigration policies. However, uncertainty had already been elevated even before that; the new administration may have further intensified the uncertainty.
I think the real cause of uncertainty lies on the interest rate front. Decision-makers want clarity on the direction of future interest rates to make informed long-term commitments. However, more serious than that is the fact that we have an economy and economic participants who have become accustomed to lower interest rates for an extended period. They have been significantly unsettled by the rise in interest rates between 2022 and 2023. As generally assumed, they are not waiting for clarity on the direction of interest rates; instead, they are crying out for interest rates to be brought down. Everyone wants rates to come down rather than learn to live and prosper with higher interest rates.
Most global central banks have begun cutting interest rates since the middle of 2024, except Japan. The European Central Bank and the Bank of Canada were the most aggressive rate cutters among them, having reduced policy interest rates by 235 basis points and 225 basis points, respectively, since the middle of 2024. Meanwhile, the Federal Reserve, the Bank of England and the Reserve Bank of India have cut rates by 100 basis points, 125 basis points, and 50 basis points, respectively. In contrast, the Bank of Japan has increased its policy interest rate by 60 basis points since the beginning of 2024. China, meanwhile, has never raised interest rates over the past decade; instead, they have reduced rates by 130 basis points over the past five years.
However, despite the rate cuts, policy interest rates in all the above major countries are much higher than they were five years ago, except in China. Considering the current situation, I don’t see rates returning to those lows of five years ago anytime soon, at least not in the next decade. Higher and rising interest rates are a more likely interest rate scenario for the next decade.
Although past performance is not a reliable indicator of future performance, average investors base their investment decisions on past performance. Generally, Indian stocks have delivered an average annual return of 12% over the past three years and an average annual return of 16% over the past five years – a superior performance, both absolutely and relatively. This exceptional performance is likely a key factor in the SIP boom over the past few years, and they seem to be sustaining the boom as well. Over the past four months, an average of ₹27,260 crores has flowed monthly into Indian equities through the SIP route, which is more than three times the average monthly SIP flow from five years ago.
As we said earlier, investors base their investment decisions on the relative merits (performance) of available investment alternatives. Domestic equities have been the preferred investment option for domestic investors, including institutions and individuals, for some time now. However, they weren’t the preferred investment option for foreign investors, as evidenced by the withdrawal of more than $2 billion from Indian equities by foreign portfolio investors over the past year. Foreign investors have a greater range of investment options than domestic investors. South Korean stocks have risen by 40 per cent and Chinese stocks have increased by 20 per cent so far this year.
Intriguingly, despite the large flow, domestic fund flows have never been a significant determinant of Indian equity prices. Indian stocks have remained essentially unchanged over the past year, despite record ₹11.4 trillion in domestic institutional fund inflows. However, foreign fund flows have been a significant determinant of Indian equity prices, at least so far this year.
Indian stock prices have declined for two consecutive months, in July and August 2025, during which foreign portfolio investors (FPIs) were net sellers. The two consecutive months of decline follow four straight months of gains, during which FPIs were net buyers. Previously, Indian stocks have declined during the first two months of this year as well, when FPIs were net sellers. Domestic institutions were net buyers in every month this year. The strong correlation between FPI flow and Indian stock prices, along with the irrelevance of domestic fund flows in determining Indian stock price movements, as evident in the fund flow data, indicates that FPIs must make a comeback to revive the fortunes of Indian stocks.
Six consecutive quarters of weak earnings growth and elevated valuation have made Indian stocks relatively unattractive to foreign investors. In a previous outlook this year, we discussed that a positive real interest rate of less than 1.5% is favourable for stock prices and corporate earnings, while a value greater than 1.5% is restrictive. Today, the real interest rate is 3.95% (Policy interest rate (5.50%) minus CPI Inflation (1.55%)), which means conditions are excessively restrictive for equities and corporate earnings. Real interest rates must shrink, either through a rise in inflation or a fall in interest rates, to revive Indian equity fortunes.
Then there is the headwind of elevated valuation. Valuation could decrease and become more attractive either through higher earnings growth or a decline in stock prices. As we saw earlier, the prevailing high real interest rates have diminished the possibility of higher earnings growth in the near term. The next option is a fall in stock prices, which is believed to be held higher by strong domestic fund inflow, particularly through mutual fund SIPs.
All manias, when they are in progress, appear to last forever. But they don’t. Eventually, all manias come to an end, most with disastrous consequences. The same could happen with the SIP mania. Determining when it will occur, how it will unfold, and the extent of the damage are unclear. Regulatory actions, investor disinterest due to better alternatives or extended periods of low equity returns are some likely causes that could trigger the end of the ongoing SIP mania. There have been some regulatory actions in recent months, in the form of tightened conditions on new fund offerings and derivatives trading. However, the continued inflow testifies that the actions were insignificant. The total SIP inflow in July 2025 was ₹28,646 crore, the highest-ever monthly flow, representing a 22% increase from July 2024 and a 5% increase from June 2025.
Clarity on the direction of global interest rates and the evolution of real interest rates in India seems to hold the key to Indian equity market prospects. Currently, the former is clouded in uncertainty, while the latter is unfavourable. Despite the record SIP inflow, Indian stock prices fell during July 2025, which should be viewed with concern. The ability for SIP flows to sustain current price levels might be waning. Anyway, now is not the time to get excited and join the party. It is a time for caution.
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