As Global Markets Take A Hit: What's In Favour Of India's Stock Markets & What's Not

Back home, there is fear and lack of confidence among investors about markets' near-term trajectory as reflected by the sharp rise in the India Volatility Index (India VIX) to 20 levels from around 12 levels just a week ago.

As has been seen in the recent past – be it correction during Covid pandemic or due to unexpected election results – domestic investors have bought the dips, even as foreigners were contemplating their moves. From foreign investor’s perspective, bad news flow globally will certainly prompt them to dump Indian equities which has a weight of around 20% in the MSCI Emerging Index (EM).

Are We Nearing A Bull Market Peak? Not Yet

But what would domestic investors do? Will the around 4% correction in the benchmark equity indices - Sensex and Nifty-50 - from their July 31 highs, be considered a routine one by local investors? Or will they take this as an opportunity to showcase their heft?  

Here's a lowdown of what's currently in favour of Indian stock markets and what is not:

India has seen many bull-run in the past: 1994–96, 1998–2000, 2002–07 and 2014–17. A 5-10% dip is considered normal in a bull run. An analysis by foreign brokerage Jefferies shows that in the current bull run, which started in March 2023, Nifty-50 has rallied for 491 days at a stretch without a correction of above 10%, which is the second longest streak in last ten years.

Although Indian equities could witness some correction in the immediate future, markets have yet not hit the peak of the current bull run. "...corporate balance sheets are light, bank advances to shares are virtually absent, holding periods remain reasonably high (so market participants have still not started renting stocks – a telltale sign of exuberance), earnings remain well below peak, net corporate issues are close to bear market lows, share prices relative to gold, consumer inflation, earnings and book values appear rich but not in bubble zone and foreign investors are underweight. At least some of the fundamentals need to make a peak for the bull market to end," said foreign brokerage Morgan Stanley in a note on August 2.

This implies that there is still some room for prices to go higher.  

But Valuation Worry Remain 

However, some section of the market think that some excesses are visible in valuations and prices. Analysts track various valuation tools primary being market cap to gross domestic product (GDP) ratio and price to earnings multiple. To point out, at 150%, India has reached the previous peak achieved in 2007 in market cap to GDP ratio.

"This variable best captures both primary and secondary market sentiments. In 2007, when the market cap to GDP hit 150% – nominal GDP was booming in mid-to-high teens, but today it is barely even in double digits. Thus, from a real economy context, market valuations are quite excessive," said Nuvama Institutional Equities said in a note on August 1.

As far as price-to-earnings ratio is concerned, post the recent dip, Nifty-50 still trades at 20.2 times one year forward earnings, well above historic averages. Small and mid-cap companies are trading at even higher multiples.

In Conclusion – Fundamentals Still Strong

Peak valuations are justified if earnings match up with that growth. “The government is creating space for a rise in private sector investment spending and leverage. This is where the next leg of earnings comes from, and therefore the next wave of stock price upside. Eventually, India is likely to head into primary balance which supports a new high for corporate leverage, private investments and share of profits in GDP. The consequent rise in share prices will also be supplemented by a further increase in the equity allocation on household balance sheets, significant global allocations to Indian stocks (reflecting India’s rising index weight) a rise in corporate issuances and a new peak in equity valuations,” said Morgan Stanley.

Finally, Indian markets are no more vulnerable to moods of foreign investors and has shown resilience to global market rout in the past. This time around India is witnessing a virtuous cycle hitherto never seen before. The heft of domestic investors has been on the rise over the last few years. Domestic investors mostly retail through their direct and systematic investment plan (SIP) flows have bought the dips.  In the first six months of 2024, inflows of Rs 1.66 trillion have been witnessed into mutual funds as against Rs 1.61 trillion seen in whole of 2023.

It remains to be seen if domestic investors buy the dips or turn cautious over global news flow and book profits or turn spectator staying on the sidelines.

(The author is a Mumbai-based analyst and researcher. Views expressed are personal)