‘Overvaluation’ of Indian Stock Market has Two Sides to it

Indian Stock Market

The Indian stock market is scaling new highs (Sensex is above 31000 and Nifty above 9600 in early June) and the market confidence is exceptionally high as indicated by the burgeoning domestic inflows. Inflows into mutual funds through Systematic Investment Plans (SIPs), which started off as a trickle, appear to turn into a flood. The demonetisation shock, crack down on black money and the GST revolution are paradigm shifts that have the potential to reset the Indian economy and alter the behavior of economic agents. There is a growing realisation that tax evasion would be difficult, going forward. Businessmen in the informal segments of the economy, who thrived on tax arbitrage, would find the going tough in future. In brief, formalisation of the economy, digitisation and financialisation of savings are clear irreversible trends. Declining interest rate is accelerating the shift of money from fixed income to equity.

For getting a satisfactory answer to this question, let us put the issue into perspective. First, let us appreciate the fact that the present bull run is a global trade. As on June 2, the MSCI world index is up 11.3 per cent YTD. The EM Index is up by 17.7 per cent in local currency. With the exception of Russia, all major markets are doing very well. Of course, India has done very well with Nifty returns of 15.5 per cent, but Argentina, China and South Korea have done better than India. So, make no mistake about this: this is a global trade powered by global liquidity which, in turn, is facilitated by the shift of funds from bonds to equity. Ultra loose monetary policy of the developed markets (DMs) had generated humungous liquidity in the global financial system and a major part of this money had gone into bonds.

In early 2016, there were $13 trillion invested in bonds yielding negative returns. Now that the Fed has started tightening, there is a near consensus that the bond party is over and consequently funds are moving to equity. There is justification for this shift, because, for the first time in almost nine years, we are witnessing a synchronized global economic recovery with almost all regions doing well. PE multiples have expanded everywhere in anticipation of recovery in earnings. This ‘hope trade’ may play out as optimists expect.

A point of serious discussion now is the market valuation. Is the market over valued? From the earnings angle, the answer would be ‘yes’. PE multiples indicate higher than historical valuations in large caps and rich valuations in midcaps and ‘hard to justify’ valuations in some small and microcaps. But, from the perspective of corporate earnings cycle, one can argue that the market is not overvalued. Corporate profit to GDP is presently at its lowest point around 4 per cent against the average of 5.6 per cent. Therefore, if corporate earnings cycle picks up and moves up to the average, the present valuations can be maintained and justified. In the next four years, a couple of years are likely to witness excellent growth in corporate earnings, which the market is presently anticipating.
Market corrections are normal and desirable. Long-term investors need not bother about corrections even if they are sharp and swift.

During the 2003-08 Bull Run, which took the Sensex from 2500 to 21000, there were eight corrections of more than 10 per cent and three corrections of more than 20 per cent. Investors, who continued to invest systematically during that period of turbulence, would have benefited from the volatility if he/she had not panicked and left the market. The same story is likely to repeat, going forward. A few years from now, Sensex will certainly move past 50000 and 60000 levels. Some globally renowned technical experts have projected Sensex levels of 100000 by 2024. The journey will not be smooth, but the destination will be reached. Disciplined systematic investment will take investors to the destination.