Are Indian Stock Markets In a Bubble?

Tue, 16 May Pre-Open

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2017 started on a buoyant note as bulls remain in charge of D-Street giving little room for bears to enter. Indian share markets reached new highs last week even though corporate earnings growth in the fourth quarter of the previous fiscal year has been sluggish. Also, with real estate and commodities going through a slump, and post-tax returns of bank fixed deposits being around 5%, market participants are looking at the equity markets to give them a decent return.

It is no secret that equity prices are being powered by excess liquidity-not just global liquidity, as has usually been the case, but also strong inflows into domestic mutual funds because of the systematic investment plan (SIP) revolution.

Strong liquidity also means the market is not worried about profit booking. In fact, the players are getting a suitable opportunity to accumulate in case of a correction. This is precisely the reason that the market, post a brief correction after hitting an all-time high, is back to the same levels within the span of a week.

It seems that the sole investment thesis in some cases is 'liquidity', which is quite bizarre since 'active' investors should be deciding on the fundamental value of stocks rather than leaving it to a vague issue such as liquidity.

The current valuation of the index - more than 22x - is rare. Over the past two decades, the NSE Nifty has traded above 22x only nine times. The implied volatility in option contracts is now at its lowest level in several years. The Indian market may not yet resemble a bubble-but it is definitely heating up too rapidly.

However, India is not the only market that has gone up, markets in the US have gained significantly since the victory of Donald Trump in November, in anticipation of higher government spending and lower taxes.

Bill Bonner, Founder of Agora Inc, was of the opinion that

Despite spending some $2.5 trillion on share buybacks over the last three years......

despite huge new inputs of buying, selling, investing, and speculating with cheap credit......

and despite crackerjack accounting folderol, removing billions of dollars' worth of 'ex-items' from the cost side of the ledger......earnings per share are lower today than they were in 2013!

So why pay 25 times earnings for stocks?

As per an article in The Livemint, the recent fall in commodity prices could also result in global risk aversion, lead to a correction in stock prices and can also affect the earnings of listed companies in the business. Protectionist policies being pursued in the US too are negative for markets and will have a direct impact on the earnings of software companies in India.

Investors in India have waited a long while, but if earnings don't recover soon enough, they might start losing patience and the increasing participation of retail investors could get tested. Also, continued flow of funds will further push markets into the overvalued territory, as fund managers will have to buy stocks even at higher levels, which will increase risk in the absence of earnings support.

Then again, globally, the interest rates will be on the rise. So, the foreign money flow into the market will remain subdued and foreign investors may even sell off India, thus playing a balancing act between the domestic and the overseas flows.

India remains one of the few exciting economies in the world-but investors should consider if the valuation at which they are buying shares is justified.

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