Be optimistic, but cautious


By Dr. V. K. Vijayakumar

Markets have been marching ahead setting new records. Even though a limited number of large-caps have been powering this rally, there is no doubt about the resilience of the market. All positive news is discounted and negative news ignored. This is the characteristic of a strong bull market. The mother market US is on steroids. Dow, Nasdaq, S&P 500 and Russell 2000 are all at record highs. The US market rally is backed by strong fundamentals. The US economy is firing on all cylinders and corporate earnings growth at 20 percent is very impressive.

Globally, stock market performance this year is mixed. After the global rally of 2017, most markets are retreating or consolidating. As on August 14, the MSCI All Country Global Index is up by 0.2 percent in dollar terms and 2.1 percent in local currency thanks mainly to the robust performance of the mother market US, which is up by 6.4 percent.  The EMU, Japan and EM indexes are down by 1.6 percent, 5.4 percent and 5.6 percent respectively in local currency. Out of the 27 major markets, only 9 are in positive territory whereas 18 are in negative territory as on 14th August. India is among the best performers.

Record levels of Sensex and Nifty raise the question of valuation. Are the markets getting over-heated? As always, there are both bullish and bearish views. Going by valuation metrics, Indian stocks are over- valued. The trailing Nifty PE is around 28. Valuations of mid and small-caps are higher than historical averages. Also, the premium for Indian stocks is at historic highs to valuations of EM peers. This raises concerns of valuation. The bearish view is that these high valuations can’t be sustained and therefore a correction is imminent.

However, it is important to understand that valuations have to be seen and assessed in context. At the height of the bull market in 2000 and 2008 PEs were around 28. But these two peaks were followed by global market crashes and economic contractions. Earnings growth also suffered. That led to prolonged downtrends in the market. But presently, India is on the cusp of growth and earnings recovery. 20 percent plus earnings growth is the base case in FY 2019 and the prospects for sustaining this earnings growth look bright. Viewed from this perspective, the present valuations can be justified.

The most important factor contributing to the resilience of the market is the strong domestic appetite for equity. Poor returns from other asset classes like bank FDs, real estate and gold have made stocks and mutual funds attractive for investors. This trend is likely to continue.

In sum, even though the markets appear highly valued from the PE perspective, the turnaround in economic growth, the uptick in earnings growth and the sustained flow of money into the market are likely to impart resilience to the market and keep it buoyant. Therefore, be optimistic even while being cautious of high valuations.


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