Mumbai: Hope trumped fear as Indian stocks closed at a record high on Tuesday following the Bharatiya Janata Party’s (BJP) unprecedented win in the Uttar Pradesh elections.
Investors saw the win as adding momentum to Prime Minister Narendra Modi’s anti-corruption, pro-development reform agenda and chose to overlook roadblocks such as the poor corporate earnings, lack of private investment and the US Federal Reserve’s expected interest rate hike.
But as the India VIX, the so-called fear gauge, plunged 11% to close at a record low, analysts warned about complacency, especially citing rising valuations.
On Tuesday, the National Stock Exchange’s Nifty index closed at its all-time high of 9,087, up 1.7% from the previous close. The Sensex closed at 29,442.63, up 1.71%, although it didn’t breach its record high. The rupee strengthened past the 66-mark to close at a 16-month high against the US dollar.
“This win for BJP would mean bolder and stronger reforms from here. Masses have applauded demonetization, so many such steps may follow,” said Ravi Sundar Muthukrishnan, co-head of research at ICICI Securities Ltd.
On the market’s wish list are measures to boost private investment, steps to resolve the Rs7 trillion bad loan crisis and labour law reforms that will boost the ease of doing business. BJP leaders have also talked about continuing the anti-corruption crusade with a focus on the implementation of the new so-called benami law in property transactions to crack down on holdings held by people under other names.
“Indian equities are likely to open/stay strong on these election results,” wrote Deutsche Bank in a note to clients on Tuesday. However, “with the market having learnt the challenges of policy implementation, the (current) Modi rally is unlikely to be as large or as extended as the one in 2014”, the bank warned.
For starters, valuations are rising. Currently, the Sensex is trading at 17.19 times its estimated earnings for 2017-18. According to Deutsche Bank, historically, at these sort of valuation multiples, the Sensex has struggled to give a positive return over the next twelve months.
There is little visibility of a broad-based recovery in corporate earnings, with consensus downgrades continuing. Since the start of this year, the 2017-18 earnings estimate has been pared by 2.5%, and the 2018-19 one by 3.43%, according to Bloomberg data. Lack of private corporate investment and a possible negative impact from the implementation of the goods and services tax, passed through higher inflation or lower growth, make the earnings outlook more cloudy.
In any case, this rally has been largely liquidity-driven. Foreign institutional investors have bought $2.8 billion of equities this year, the highest in any Asian country barring South Korea. Domestic investors have been buyers as well (though to a smaller extent), helped in part by year-end investments by insurance companies, said Kunj Bansal, chief investment officer at Centrum Broking.
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The FII inflow has made the rupee the third-best performing currency in Asia this year, with gains of 3.2% against the dollar. On Tuesday, it gained 1.2% to close at 65.82—a level last seen on 6 November 2015.
However, an expected interest rate hike by the US Federal Reserve could lead to a dollar squeeze, hurting trade competitiveness and dollar inflows.
“Higher US bond yields and a stronger US dollar may act as a headwind for emerging markets, which have rallied strongly over the past three months,” said Kotak Institutional Equities in a note to clients on Tuesday. “Global markets will have to balance the positives of stronger US and overall developed market economic growth (brighter earnings outlook) with the negatives of higher bond yields (higher theoretical cost of equity).”