Highly polarized valuations unsustainable

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Globally stock markets are in a bull run. MSCI All Country Index and MSCI Emerging Market Index are up by 21.3 percent and 10.71 percent respectively for 2019 till November 19th. This bull run has been triggered by the risk-on in global markets following the synchronized rate cuts by all the leading central banks of the world. Cheap money is chasing risky assets like stocks pushing up their valuations. Market risk is rising.

The situation is pronounced in India where the domestic economic headwinds are strong. Poor corporate earnings in 5 years in a row have pushed up market valuations. Nifty is now valued at around 20 times FY 20 earnings. This is higher than historical averages. As Sensex breaks records and Nifty hovers around record highs investors have to be a bit cautious.

It is important to appreciate the fact that market valuations in India are highly polarized. Institutional money -both foreign and domestic- is chasing large-caps pushing up their valuations. Since there is a huge premium to quality now, valuations of quality large-caps are exceedingly high. There are high quality names quoting at PEs of 60 to 80. Some skeptics have gone to the extent of saying that these valuations are in bubble territory.

Valuations in the Indian market can be summarized as follows:

  • Market, generally, is fairly valued.
  • Quality large-caps are richly valued.
  • Mid and small-caps are under-valued.

This doesn’t mean that richly valued large-caps should be sold and under-valued small-caps should be bought.  It makes sense to remain invested in quality large-caps. Many of them have been consistent compounders with an enviable track record of phenomenal wealth creation. So, remain invested in these bluechips even though there is a case for partial profit booking in some of these highly valued large-caps. Certainly this is not the time to aggressively buy these richly valued stocks. SIPs in large-cap funds, of course, make sense.

Markets have a tendency to overreact- both on the upside and downside. Impressive growth, good growth prospects and earnings visibility attract money to stocks pushing up their valuations. On the contrary, business headwinds, temporary growth pangs and poor profitability push valuations down. This leads to polarized valuations.

The polarized valuations present an opportunity to buy attractively prized mid-caps. Most small-caps are still struggling in this business down cycle. Therefore, investors have to be careful in this space. But there are attractively prized mid-caps, which have the potential to give very good returns. Investment in this segment should be done, ideally, through the mutual fund route. Multi-cap and Large and mid-cap segments are ideal for investment presently. Our recommendations of mid-cap, multi-cap and large and mid-cap funds, given in Geojit Insight will guide you in your investment decisions in these difficult times.

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