Nifty at a new high: Why investors should not get blinded by psychological levels

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Nifty at a new high: Why investors should not get blinded by psychological levels

Indications of a more gradual hike in interest rates by the US Federal Reserve kept global stock market sentiments upbeat on Monday. Taking positive cues from Asian peers and the Wall Street, Indian equity indices soared to new highs.

While the Sensex settled at a closing record of 38,694.11 points, the Nifty 50 breached the psychological mark of 11,700 and ended the day’s session at 11,691.95. Though India’s equity benchmarks are steadily rising, investors are advised to tread with caution.

Fundamental challenges such as delayed revival in corporate earnings, a not-so-good macroeconomic situation and expensive valuations remain. Globally, concerns of trade wars and domestically, the forthcoming elections could keep volatility high on Dalal Street in the days to come.

While India Inc’s earnings in the March and June quarters may have exceeded analysts’ estimates on the sales and revenue front, one has to take into account the low-base effect ahead of GST (goods and services tax) implementation in July last year. So, in order to gauge whether earnings have improved, second quarter earnings of FY19 will be closely watched.

But Bloomberg’s one-year forward consensus estimates for Nifty EPS (earnings per share) do not show an encouraging picture. The Nifty EPS forecast has fallen from ₹608.33 in April to ₹578.74. This is the lowest so far in FY19 and yet the markets continue to rise regardless.

Although a depreciating rupee would benefit exporters such as IT, pharmaceutical and metal firms in the September quarter—boosting overall Nifty EPS estimates—from a macro perspective, a strong currency doesn’t bode well for a net importer like India.

The upshot of all this is that valuations in the Indian market are ridiculously high. As the chart shows, India’s valuations as well as its premium to emerging market peers is currently the highest since the Lehman crisis.

“In Q1FY19, despite the 3% cut in our coverage universe’s FY19 EPS estimates, markets have rallied 7%. This has led to a re-rating of Nifty forward PE to 19x (a post-Lehman high). Furthermore, India continues to outperform EMs and, in fact, its valuation premium to EMs is now 70% (versus long-term average of 40%) and is at post-Lehman crisis high,” said Edelweiss Securities Ltd.

Meanwhile, the recent trend of a handful of heavyweights driving the index up remains.

According to Deepak Jasani, head of retail research at HDFC Securities Ltd, since the ongoing crisis in Turkey and much-talked about trade wars haven’t catapulted into a larger problem as yet, the market seems to be shrugging those fears off for now.

“There is disbelief among market participants with respect to the stock market’s relentless rise despite macro and global concerns. Individual portfolios aren’t seeing much returns probably because the midcap and smallcap stocks haven’t seen a drastic recovery yet. Considering the peak valuations, a correction is anticipated, but it is difficult to predict when. However, if corporate earnings start showing up then that should allay some concerns on the market’s valuation front,” he added.

While domestic investors continue to be buyers of Indian stocks, it remains to be seen if foreign investors turn sellers given the falling rupee.

In short, while it’s difficult to pinpoint one factor that is driving the Indian stock market northward apart from liquidity, unless earnings pick up, this rally is unlikely to sustain. Also, the sky-high price-to-earnings multiple and a relatively rich valuation premium leave the door wide open for disappointment.

source: livemint