The world equity market has climbed higher since the low touched in the month of March and it rallied seamlessly, without any valid amount of correction. The world equity market is up by about 50%, from the 52 week low, in less than four months. They are just a fraction behind the pre-Covid level high which it touched in the month of February.
India is no exception, it did start slow compared to the rest of the world, but today it is grabbing more returns than the first players. Post-mid-May, India has been catching-up and outperforming other equity markets. It was supported by a change in FII inflows from negative to positive as they started to invest more in Emerging Markets post the huge amount of quantitative easing announced by the Fed. This trend is equally supported by retail and domestic investors. Post which volatility reduced and the degree of consolidation we were experiencing on a weekly basis increased, India VIX reduced from 40 to 25. The overall trend of equity improved when Fed announced guarantee and buyback of private investments and the Indian government’s guarantee for MSME and SME.
This rally was first initiated in the US market while the rest of the world was underperforming. Now EMs are outperforming the US except Nasdaq (technology index). Today broad index like S&P500 is underperforming, especially in the last one month. Based on the last three months’ data, India is up by 9% and 25% respectively while US S&P500 is up by 5% and 15%.
Please note that this is the normal tendency of the best to perform first, and while they are consolidating the dependents may do better. Today the main benchmark in the US has been flat for the last one and half months while India is up by 15%. Though we don’t know for how long the consolidation period of the US market may continue, while in valuation terms they are above the pre-covid level, S&P500 is at 22x on P/E 12-month forward basis compared to 18x. The question is whether this rally has gone far ahead and avoided the fundamentals. This rally has factored-in only the positive side like the early availability of a vaccine, which may be developed in the next 6 to 12 months, while bankruptcy risk of private entities has been reduced through government guarantee. Both these factors have added confidence in the minds of investors who are with flush of money in hand. Risk of private financial asset depleted post the guarantee of US FED and respective countries, which importantly added trust between investors and the financial market.
It is understandable that the long-term basis will be positive and this has been our view during the last four-five months. But today our confidence in this rally has come down, and are assessing if it has stretched too fast and is trading beyond fundamentals. Business in the street is still very weak and local lockdowns are increasing. A vaccine will take another 6 to 12 months to be developed and delivered. The optimism has reached so far today that it is being assumed that the lethal effect of covid is lower than thought earlier based on sample of analysis. But please note, based on the new norms of business we cannot expect growth in the economy for next 12 to 18 months, then how come we can value stocks and market at high premium to pre-covid level.
Today Nifty 50 one year forward P/E is at 20.5x which is higher than 18.5x before covid. Fine, it may be due to the low actual base of FY20 and lack of growth in FY21. The valuations may be posting high because of a few sets of stocks that have high weightage and better outlook even during this health crisis period. Still, on historical basis we are in the bubble region in terms of valuation and it is advisable to be cautious and place assets in safe categories and sectors.
Markets are very joyful today due to a large amount of money in hand. It is assuming that fundamentals will jump from next year onwards which is valid and we may have to pay premium valuation for a long-time. But still, in the end, the market will revert as per valuation and reality of economy which may stay weak for the next three to six quarters. The Q1FY21 results are being announced and are estimated to be weak. The consolidated PAT of Nifty 50 is expected to de-grow by -38% on a YoY basis, as per our assessment of Bloomberg consensus estimate of 50 constituent companies. The initial result is in tandem or marginally better given the initial set of quality companies, the worst may be yet to follow.