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Markets at record highs on rate cut hopes, but are high valuations justified?

LiveMint logoLiveMint 13-07-2017 Nasrin Sultana

Mumbai: The markets touched record highs as the 30-share Sensex breached the 32,000 mark, while the Nifty is eyeing 9,900 on Thursday. Investors are riding on firm macro data as investors are expecting Reserve Bank of India (RBI) to cut interest rates in its monetary policy review in August.

Global cues are also supportive with firm Asian markets. On Wednesday night, in her testimony, Federal Reserve chair Janet Yellen commented that the US Fed’s interest rate hike would be gradual and that it is likely to start unwinding its balance sheet later this year.

Back home, India’s retail inflation cooled down to 1.54% in June from 2.18% in May, which is 50 basis points (bps) below the lower band of RBI’s mandated target of maintaining inflation within the 2-6% band. One bps is one-hundredth of a percentage point. Consumer Price Index (CPI)-based inflation, excluding food and fuel, which has been a key concern for most of the monetary policy committee (MPC) members, also moderated below 4% in June, a record low.

Deutsche Bank expects the central bank to cut the policy rate by 25 bps on 2 August, thereby pushing the repo rate down to 6%.

However, India’s premium valuation is still a concern for analysts. In a 12 July research note co-authored by Sanjay Mookim, research analyst at Bank of America Merrill Lynch, said that with the recent rally that is also now at cyclical highs, there is little room for further upside, while the market is susceptible to reversal of global tide. The brokerage is cautious int he near term, setting the December Sensex target at 30,000.

“MSCI India trades at a large price to earnings (PE) premium to Emerging Market (EM) even though earnings growth is not materially higher. This is driven by consumer facing stocks and only partly explained by higher Indian return on equities,” the report added.

In terms of valuations, Indian markets are most expensive among peers. Price-to-earnings (PE) ratio of Sensex and Nifty is at 18.3 and 17.7, respectively, while MSCI Emerging Markets is at 12 and MSCI World is at 16.

Morgan Stanley said valuations are not signalling excesses. It said Indian stocks are attractive relative to US equities, local bonds and in line with history on both an absolute as well as a relative basis.

According to Morgan Stanley, we are entering a new growth cycle in which earnings could compound annually at about 20% for the coming five years. “Valuations are not signalling excesses. Indian stocks are attractive relative to US equities, local bonds and in line with history on both an absolute as well as a relative basis,” it said in a note on 5 July.

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