How valid is today’s open concern over high valuations & market correction?


Equity has been and will continue to be the key instrument of wealth creation, be it short-term or long-term basis. Since liberalisation, our economy has been construed as a developing chariot of investment. During this time passage, the Indian market has passed through many situations of overvaluation and undervaluation, mostly biased by global factors. The market was very lucrative during the collapse of March 2020 and expensive in the latest quarters.

Today, we are constantly hearing from experts that the Indian market is very expensive and bound for a correction. I would like to express my view that, during the last two decades, even when the market was expensive and bloodbath was happening, there was never such an open negative bias in the majority.

The Indian market always had a positive undercurrent driven by a strong domestic market and key export opportunities. Even during the global crisis of 2008, we used to hear an outlier positive view that India can de-couple from other emerging markets (EMs).

But this time, the bias seems completely opposite, that too when everything is working well. On a personal note, in my career of about two decades, I have never heard, so openly, such sweeping statements concerning the trend of the market. Sometimes I am astonished to see such open discussions and views that the market can have a decent correction. Well, I hope that the view is more on a medium-term basis. This time, it is determined that equity is extremely highly valued and is completely driven by liquidity. FIIs and retail investors seem more positive on India than domestic institutional investors.

To be cautious on equities is common advice these days. Investors are advised to guard their portfolio by reducing exposure in mid and small caps and develop a balanced portfolio by including gold and debt. Undoubtedly, these views are useful and will help to generate stable long-term returns by adjusting the risk, which is assumed to be high including by pioneer money managers and experts.

Having said that, though the suggestions are worthy, given the soothing equity environment, in the medium to long-term basis, it is causing confusion in the minds of the investors. Many questions arise, like how to span out restructuring of my portfolio, should I swiftly shift to largecap, debt or gold and in what proportion, how much correction is expected and when am I supposed to shuffle back to equities and manage taxation? Or, if this is a short-term correction, should I undertake such complicated strategies? In what theme should I transit? Is it really the best time to reduce small caps?

To help, first about the correction, we agree that consolidation will be good for the market. When the Nifty50 was between 13,000 and 14,000, we hoped for a correction of about 5 to 7 percent, which suffices, given strong earnings growth and low-interest rate. Well, correction of that magnitude did not happen, it was only a small fraction, of about 2 to 3 percent. We have an excess and overvaluation in the market, the risk of a higher correction has increased. We feel that a correction between 10 to 15 percent is possible but the market is bound to maintain its buoyancy in the medium term.

We also notice that the main thesis for the correction is valuation, which is presumed as very high P/E. To emphasise so much on a parameter, which is mere math due to low earnings, does not make sense as the core factor or the best method to understand valuation. As we know earnings growth is bound to be high for the next two years, we are still in the COVID problem and have to maintain fiscal and monetary support. When we look at the negative real interest rate in India and Market-Cap to GDP of 80 percent, we are not expensive but on long-term average.

If a market is at a big risk of a correction, then cash should be the king of the portfolio. A review of MF schemes shows that high amount of cash is visible in balanced funds, but not in other equity schemes, including Mid & Small caps. They are fully invested, though the general view is to reduce mid and small caps, not seen in the scheme mix.

We have a view that mid and small caps will outperform for the next one to two years. Largecaps are also highly valued. Actually, this is a good time to have a contra bet on mid and small caps since there are opportunities in many pockets of the market being cheap, like ancillaries, NBFCs, industries and cyclicals. They have not benefitted from high liquidity and re-opening of the business and are bound to experience demand, in the future.

This is the time to be stock and sector-specific and avoid weak quality companies, dips should be buying opportunities. Also, many sectors like IT, pharma, chemical and exports, which seem overvalued today based on historic trend, still have good possibilities for further re-rating due to complete revolution in their businesses.

About a quarter back, we were suggesting 60 to 75 percent holding in equity. Recently, we have been advising profit booking, the exposure can be cut to 50 to 60 percent, depending on risk averseness. The mix on equity can be increased in the near future, as we get a correction of 10 to 15 percent in the broad market, with a multi-cap approach and bias on the sectors mentioned above including Mid & Small caps. In the expected correction, the amount of dip in good names will be low.

The biggest risks in the near-term are a fall in inflows of FIIs, retail and the budget. The possibility of FIIs completely changing course in 2021 or in the medium term is low rather than in short term due to volatility in bond yield. US bond yield is increasing and may impact the market in the short term but unlikely to jump suddenly. Unless inflation explodes or Fed increases rates, the possibility of this is low since core inflation and employment is still low. Most likely, in the medium term, we will have a scenario of rising yield and equity too.

Retail inflows in the domestic market are strong because they are in good profit but can reverse if the market collapses, which again looks unlikely. Retail inflows can also be impacted by changes into stringent trading norms by SEBI regulation, today no such developments are foreseen.

On the budget, expectation is high which brings a domestic event risk to handle. A domestic event risk has never impacted the long-term trend of the market unless it brings higher taxation and political risk. The budget will not impact the market unless it tinkers with tax, especially FIIs & capital gains tax. The possibility of such looks dim, considering the 2020 Budget when the FM had to roll back the super-rich tax on FPI. This time the short-term risk is that the government is expected to spend more without bringing crowding out effect on private borrowing and capex due to weak fiscal stiuation.

A domestic event risk is hovering and global volatility due to lower-than-expected fiscal stimulus in the US, rising bond yield and double recession. But such a short-term correction will create an opportunity for equity gains in the medium term because we have a better chance of rising global equity and bond market in 2021. A correction will be ultimately good for the market.

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