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Business News/ Opinion / Views/  Opinion | Now to sustain this surge in equity prices
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Opinion | Now to sustain this surge in equity prices

Stock indices are on a roll, investors are piling in from far and wide, and grand forecasts are being made. But for this to last, corporate earnings need to boom on the back of reforms

 (Jayachandran/Mint)Premium
(Jayachandran/Mint)

It took a few years longer than some equity bulls had expected back in 2014, but now that Indian stock indices have held on to their newly attained peaks—the Sensex stayed above 40,000 on Tuesday and the Nifty above 12,000—investors with long horizons must wonder how sustainable these levels are.

The economy had ended last week on the dour news of its annual growth having slowed to 6.8% in 2018-19 and just 5.8% in its last quarter. Corporate earnings have mostly been weak, a consumption slump has followed an investment slide, and the export outlook looks bleaker than before. The government figure for unemployment, meanwhile, was confirmed to have reached a high of 6.1% last year. However, most of that is in the past now, bulls argue, and markets care only about the future. For instant cheer, what we have is the prospect of a stimulus package: Since the government has little fiscal space available, with reckless spending not an option, hopes are being pinned on a rate cut by a central bank that need not fear inflation being imported in oil tankers now that crude prices have eased. For an extended bull run, we have heady expectations of structural reforms, perhaps even the tough ones.

To value investors, though, most buyable stocks look overpriced. The two big indices are trading at almost 20 times this year’s estimated earnings of the companies that compose them. Their price-earnings ratio is close to 30 if calculated on last year’s income. By an old rule-of-thumb, retail buyers looking to “buy and hold" are advised not to pay more than 19 for every rupee of earnings, unless they expect a profit boom in the years ahead. If institutional buyers are busy buying, it’s because analysts are betting either on a revival in corporate performance or on capital gains as the ongoing rally gathers force.

Money, after all, is flowing in from various quarters. Domestic optimism is running high, even as foreign portfolio investors pile in and push up share prices. Last year, they were net sellers. However, in the first five months of 2019, they are reported to have pumped in more than 75,000 crore already. More inflows are likely. Global funds appear to be wary of US shares as America’s trade war with China worsens, and their flight to US bonds has flagged now that bond yields have fallen, an effect of rising demand for debt assets as well as the US Fed’s decision to stall the reversal of its extra-easy-money policy put in place to tide over the Great Recession about a decade ago. In such circumstances, Indian capital markets look especially attractive.

That India should play a safe haven for international investors is ironic, of course. The usual pattern has been for foreign funds to flee at the first sign of global uncertainty. Yet, it’s premature to bask in the satisfaction of this shift. There is no guarantee against sudden outflows. For our stock prices to hold steady at such elevations, corporate performance will need to catch up with what’s expected under a best-case scenario, one that factors in turnarounds on a wide range of Indian economic variables. Structural reforms could enable this. Even politically risky policy revisions could get a go-ahead from a prime minister who has very little reason to worry about his popularity being vulnerable to the short-term shocks of “shock therapy" reforms. The wherewithal exists. It’s a question of will.

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Published: 04 Jun 2019, 09:04 PM IST
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