Even as both the benchmark indices, Sensex and Nifty 50, are hovering close to lifetime highs, it may be remembered that the mood at the start of the year was rather grim. Many brokerages had put single-digit year-end targets for the broad indices at the beginning of 2018. By April this year, some downgraded the targets further. For example, Citigroup had a December 2018 Sensex target of 36,900 early in 2018 which went to 35,700 in April 2018. Now, the Sensex has breached even its latest upward revision to 37,300. Similarly, CLSA downgraded its initial December 2018 target for Nifty from 11,400 in January 2018 to 11,000 in April 2018. Morgan Stanley at the start of the year awarded just a 30% probability to a bull market scenario, wherein the Sensex’s December 2018 target could head to 41,000.
As we enter September, most of these forecasts don’t hold true. In fact, it is the least probable outcome that is most likely to come through. Does such an overshooting of expected benchmark levels mean that there will be a reversion in the last quarter of the year? Or have investors shunned bad news believing that the good will get better?
Let’s take a look at what is happening globally. In the US, the S&P 500 has recovered from a brief downtrend and is up 7.6% year-to-date (YTD) and the MSCI Emerging Market Index is up 7.71% for the same period. Back home, domestic investors have kept the flag high; so far this year, domestic institutional investors have made net purchases to the tune of ₹70,000 crore, while foreign investors have been net sellers.
According to Andrew Holland, chief executive officer, Avendus Capital Alternate Strategies, as asset manager focused on alternate strategies, “Markets should ideally rise in line with earnings growth. A 15% earnings growth expectation for the year is reasonable and the index is already up around 12%. If one were to extrapolate this, the return expectation is not very high for the rest of the year. At the same time, global markets are also at a high and it’s hard to understand what’s driving that.”
The rally in the domestic market is more prominent for large-cap stocks than their mid- and small-cap counterparts. The BSE Mid-Cap index is down 5.8% and the BSE Small-Cap index is down 11% YTD despite the recent recovery. Moreover, credit for the rally goes to the unrelenting upward move in five or six stocks which have delivered 30-50% return. At the bottom of the Sensex, there are stocks which have fallen 30% too. This is not too far away from what is happening in the US market. In the S&P 500, the top 10 stocks are the big contributors to the rally so far this year with a return of 60-140% YTD.
I.V. Subramaniam, head-equity, Quantum Asset Management Co. Ltd, said, “Looking at Sensex per se may not give the best picture. Investors are concerned about safety and find comfort in a handful of stocks. The rally to the top is very narrow; it does seem that a similar trend is playing out in the US equity market too.”
While there may not be a direct correlation between what is happening in the US markets and in the domestic equity market, there is similarity in the unwillingness to let go of what is perhaps over bought already. Moreover, flows are not stopping, hence, buying continues. But if investors are flocking to a handful of perceived safe and stable stocks, it might mean there is uncertainty about the value in the broader market.
If you are a long-term investor, you may choose to ignore valuations and continue regular investments, but it helps to be aware that at rich valuations—i.e. when stocks are priced to perfection—the chances of a steep correction are high.
The trailing price-to-earnings multiple of top five gainers on the Sensex is around 20-29 times, with one stock even at around 70 times. These are rich valuations. According to Shyam Sekhar, chief ideator and founder, iThought, “Valuations are still high. If money continues to flow, stocks on the top will simply rotate. The ones contributing the most may correct, but others will quickly take their place.”
High valuations leave little or no room for mistake. Markets can get jittery if domestic macros or external factors don’t move in a positive direction. “If you consider the two outcomes; a positive global growth will come with higher interest rates and we must remember that debt is higher now and also with higher interest rates commodity prices will be higher, given these outcomes India will be worse off. If, on the other hand, the outcome is a US-China trade war, there could be a recession in the US, triggering a fall in bond yields, commodity prices and a global sell off. In which case too, we will get hit. I don’t see why the market shouldn’t fall,” said Holland.
What should you do?
“High valuations do not take away from improving fundamentals and a changing economy. We keep looking for good opportunities even in these highly priced markets,” said Subramaniam. A catch-up in corporate earnings in underway and this could mean that any correction becomes more a tactical buying opportunity rather than a reason to exit. If you want to remain invested in equity gainfully in the near term, focus on careful stock selection.
It’s hard to shift gears if you are a mutual fund investor, so make sure that you are in good quality funds. If you are approaching any financial goals, say, 2-3 years hence, it might be a good idea to book profits and shift into products that give stable returns. For others, staying with your asset allocation will be the key.