Ticking time bomb: Have high valuations triggered cash pile-up?

However, experts said investors should not let the fear of missing out (FOMO) dictate their decisions and must instead focus on valuations, which are no longer as enticingly low as they once were.

While it took 17 years for the Nifty 50 to gain its first 5,000 points, the index has since evolved from a marathon runner into a sprinter.

Indian equities have been resilient, driven by a strong macro-economic environment, deleveraged corporate balance sheets, benign asset quality for banks and a broad-based earnings growth across sectors, explained Swarup Anand Mohanty, CEO of Mirae Asset Investment Managers (India).

“These factors, coupled with strong flows from domestic investors, have led to higher valuations, particularly in the mid- and small-cap space, which are trading at premium in both absolute as well as relative terms," he said.

Also Read: Why are infra and capital-goods stocks in demand despite premium valuations?

“Markets are significantly above fair value. Do not be hurried in incremental equity allocations," Manish Gupta, founder of Solidarity and a protege of Rakesh Jhunjhunwala, said in a quarterly update to investors. He said FOMO should not influence decisions if one is under-allocated.

“A fair portion of our positions are also at valuations where we will not initiate fresh purchases. However, we would not exit these either as they are not in euphoria. Taking cash off for small gains and attempting re-entry is not a prudent approach," Gupta wrote.

Switching to cash

What’s more is that several fund managers have taken aggressive cash calls. A portfolio manager who preferred to remain unidentified said he is wary of valuations in the mid- and small-cap space and has decided to hold 50% of his portfolio in cash.

Christopher Wood, global head of equity strategy at Jefferies, said Indian equities have been “amazingly and surprisingly resilient" but one should be careful while allocating fresh money to India now.

“If I am given a $100 to invest in India today, then I would only put in 1/3rd capital and hold the remaining two-thirds in cash, waiting for more favourable opportunities or a meaningful correction," Wood told Mint.

Legendary investor Jim Rogers says he is not overly concerned about India from a valuation perspective at this stage. He told Mint that "presently, India is not overvalued, but if the uptrend continues, it could turn into a bubble."

Rogers explained that there are often prolonged periods of inactivity in the markets, followed by bursts of heightened activity, during which an influx of investors—both seasoned and new—enter the scene. The surge in participation can result in a situation spiralling out of control, ultimately leading to the formation of a bubble in which asset prices “go much higher than they ever should have been."

Also Read: Nifty 50 could correct in short term amid stretched valuations, say analysts

“Bubbles are only evident in hindsight, and we might be in one for the last 10 years, honestly. It will only be known later, looking through the rearview mirror," said Deepak Shenoy, founder and CEO of Capitalmind. 

Regardless, the markets may crash at any time, without warning, so Shenoy suggests investors be ready to lose if they are investing now or at any time.

“If you can't stand the heat, the kitchen is not a good place to be," he said.

Wood said some euphoria does exist in the market, but it is more pronounced in sectors such as defence, electronic manufacturing services, and capital goods.

Nevertheless, both Wood and Rogers are taking the long-term view and remain bullish on India's potential. However, they do not believe that the recent 4% decline is sufficient to justify entering Indian equities at this juncture.

Vikas Khemani, founder of Carnelian Asset Advisors, said investing in India for the long term is sensible as the country is undergoing a transformational phase.

“When the tide turns down, small-cap and mid-cap companies will bear the brunt first," he noted.

Risk of drawdowns

In the short term, though, Khemani sees the possibility of some drawdowns.

The Nifty 50 has returned 10% so far in 2024. Some experts argue that given these high valuations, five-year returns could be modest, with significant risk of huge drawdowns. Additionally, slowing earnings growth and a weakening US labour market hint that an inflection point may be near, while rising recession risks in the US could curb investor appetite for equities.

Also Read: Jefferies surprised by Indian market’s resilience post election

According to a report by Nuvama Institutional Equities dated 1 August, “Indian equity valuations are now extreme: market cap to GDP is 150% — all-time high (2007 peak: 150% of GDP); median trailing P/B of BSE500 company is 6x with 15% RoE (2007 peak: 4x with 25% RoE)."

The brokerage said valuation matters “very much for medium-term returns." In fact, they explain 70–80% of the five-year returns as it best captures growth expectations, Nuvama added.

All said, corporate earnings growth is what will keep the markets going, according to Khemani. While identifying euphoria in sectors such as railways and defence, which have surged ahead of their fundamentals, he advises exercising caution in these areas.

Further decline?

Bill Gross, the renowned "Bond King" and co-founder of Pacific Investment Management Co. who once managed the world's largest bond fund, recently tweeted, “Is there any media figure willing to say ‘bear?’ ... Investors should stop talking about buying the dip and start asking about selling recoveries."

This suggests that investors might want to consider taking profits or trimming their positions during market recoveries because these rebounds could be temporary and followed by deeper declines.

Taher Badshah, chief investment officer at Invesco Mutual Fund, recently told Mint in an interview that while a 4% correction is healthy for the market, it is possible that we might see a further decline of 5-7%.

For things to take a turn for the worse, a lot would have to go wrong, like a delayed rate hike or escalating tensions in the Middle East, he added.