A melt-up in Indian equities?
Jeremy Grantham, well-known value investor, has recently predicted a “melt-up” or end-phase of the bubble in US equities before they see a steep fall. Is something similar in the offing for Indian equities?
The irony is that Grantham believes that US investors should diversify into emerging market assets. In his most recent newsletter, he says, “What I would own is as much Emerging Market Equity as your career or business risk can tolerate.” Investors seem to be following his advice about emerging markets with gusto in the New Year.
Global equity markets are in a euphoric mood. Asian markets rallied on Monday, taking cues from the robust up-move seen in US equities last week. Strong signs of economic recovery in major economies give their respective stock markets a reason to celebrate. In a rub-off effect, the National Stock Exchange’s Nifty index too surged above 10,600 point levels, touching a record high on Monday.
Indian equity investors are pricing in a V-shaped recovery after the vicissitudes of demonetisation and the introduction of the goods and services tax, with their hopes pinned on higher exports, higher consumption and even a comeback in capex. Threats posed by rising crude oil prices, a ballooning fiscal deficit and higher interest rates are being airily dismissed.
The equity market’s surge is in sharp contradiction to the performance of the bond market, which has seen a sharp increase in yields over the past few weeks.
According to some market analysts, the sentiment on D-Street is being driven by expectations of improved corporate earnings in the third quarter. Earnings announcements begin this week. The momentum is said to be further buoyed by continuous liquidity inflows, especially by mutual funds. They see some more legs to this rally.
Others caution that a significant revival in corporate earnings is still some time away and warn of a sharp correction in case of disappointing results. Also, the frenzy seen in mid-cap and small-cap stocks, which continue to outperform key indices, is something to be wary about.
“Indian equity market is overbought going by historical standards and a correction is overdue. While there are a couple of individual mid and small stories where the rally may be justified, the whole lot rallying is worrisome. To me, the upsurge seen in Indian equities cannot be attributed to ‘January effect’ because that usually happens when new fund allocations happen by larger FPIs (foreign portfolio investors) in the new calendar year; but for Indian equities, lately every month has been a month of record inflows (from mutual funds),” said Deepak Jasani, head (retail research) at HDFC Securities Ltd.
The January effect is a seasonal increase in stock prices during the month, when the rally is attributed to an increase in buying by funds making fresh allocations in the New Year.
Concurring, Sanjiv Bhasin, executive vice-president (markets and corporate affairs) at India Infoline Ltd, added, “This rally is unlikely to sustain. Premium in Nifty Futures has fallen to about 16 from the level of 50 and the long positions currently building up is typically the buying that happens before the big event—the Union Budget. So, this could be the last leg of the rally and the long overdue correction may be just around the corner.”
Valuations of Indian equities are expensive. However, as the chart shows, the current one-year forward price-to-earnings multiple of the Nifty, at around 18 times, is lower than the levels seen during the same month in 2015 and 2008, indicating that there’s enough room for a melt-up.
But as Sanjeev Prasad of Kotak Institutional Equites points out in his latest report, high valuations and “strong” currency are “bad” starting points for the equity market in calendar year 2018. The Indian currency has gone up 1.5% against the US dollar in the past one month.
“A de-rating of multiples (on higher domestic and global interest rates and/or earnings disappointments) and sudden weakness in the Indian rupee can hurt the performance of the Indian market,” cautioned Prasad.
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