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Nifty at 9,400: How rational is this exuberance?

LiveMint logoLiveMint 10-05-2017 Harsha Jethmalani

A risk-on rally globally is driving many equity markets to their historic highs. Benchmark equity indices in countries including the US, Germany, Turkey, Korea and Pakistan have hit their respective life-time highs this month.

A relief rally in global markets following Emmanuel Macron’s French election win signals that at least for now, there is not much that the market is worried about and is breathing easy. The level of complacency among market participants can be evaluated by the steep fall seen in Chicago Board Options Exchange (CBOE) volatility index (VIX). On 8 May, the fear gauge fell to 9.77, the lowest since 1993.

Indian indices too are on a roll. Key indices such as the Sensex and Nifty and Bank Nifty touched fresh record highs on Wednesday. Mid caps and small caps indices also saw sharp gains. Sector-wise, barring IT and realty, all others surged, with telecom being the highest gainer.

Why telecom, where there has been so much blood-letting? Deepak Jasani, head of retail research at HDFC Securities Ltd, believes that since corporate earnings are yet to catch-up, in sectors like telecom, market participants are probably selling on expectations and buying on the announcement.

While subdued India Inc. earnings remain a worry, other factors are driving this rally. The India Meteorological Department’s (IMD) prediction of an above-normal monsoon and easing of El Nino concerns have added to the already prevailing optimism. Secondly, domestic institutional investors (DIIs) continue to lend strong support and remain buyers.

“Surge in mutual fund equity inflows is beginning to insulate the Indian equity market, which has so far been largely determined by the velocity of foreign institutional inflows. Since May 2014, which saw the beginning of the shift towards increasing financialization of household savings, the decline in MSCI India during periods of FII selling has reduced to less than 1% (median), illustrating the increasing potency of domestic equity inflows and the powerful offset these flows have begun to create against FII selling,” a Deutsche Bank Markets Research report has pointed out.

Indian equity valuations are increasingly getting made-in-India and are deriving dominant support from this trend of consistent rise in investments through systematic investment plans, it added. The shift in household savings from the beleaguered real estate sector and from underperforming gold to the stock market has fuelled a surge of liquidity into stocks.

Talking about valuations in May so far, MSCI India continues to trade at 34% and 41% premium over MSCI Asia-ex Japan and MSCI Emerging Market indices, respectively. Thus it remains an expensive bet.

Also, over the last 12 months, while world market capitalization has increased 14.4%, India’s market cap has increased 34%, said a Motilal Oswal Securities Ltd report (Chart 1). With that, India’s share in the world market cap rose to 2.7% in April, above its long-term average of 2.4%, the report added.

Note, though, that one of the factors supporting higher stock market valuations is lower domestic interest rates. With bank deposit rates so low, investors have been increasing their exposure to equities. Also, as Chart 2 shows, equity valuations have been higher when yields are lower.

The bulls are partying but market participants already invested are advised not to get carried away, since the market looks overbought. “Though the market continues to be on an upswing, investors should ensure that their equity exposure as a percent of total wealth does not go much above the planned proportion,” Jasani recommended.

Concurring, Sanjiv Bhasin, executive vice-president (markets and corporate affairs) at IIFL Ltd, said: “Positives have been priced in, so we anticipate a correction of 7-10% in the next two months. The way in which mid caps are rallying and valuations at which they are trading, despite earnings not catching-up is a concern. It is the mutual fund houses that have large exposure to mid caps so that they can play the beta, but FIIs park funds in large caps, so even in that sense, there is froth.”

He suggested taking some money off the table.

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