The financial markets generate a lot of number on a per second basis. There are people who have made it a profession to convert this information into trends, buy-sell signals, charts and pivot tables. Over the last 18 years of financial journalism, I have realised that every number has a story to tell. And these numbers as a trend normally never lie. I am forever looking for these trends.
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The S&P BSE Sensex touched 30,007.48 mark on April 5, 2017 to close at 29,974.24. The last time the Sensex crossed 30,000 was on March 4, 2015. Over the said period, 600 stocks saw their prices double. Inside the Sensex, Maruti Suzuki (70 percent), Reliance Industries (60 percent) and Tata Steel (42 percent) have been the biggest gainers. The total market capitalisation of the BSE touched Rs 123 lakh crore for 3000 companies.
Most of the brokers and market players are expecting the market to scale up further, based on an improvement in macro-economic factors as well as a stable government at the centre.
Foreign investors see the country more stable post-demonetisation. Some brokerage houses had said that the growth rate of the country would go down for the quarter ended December 2016. But that did not happen; the economy maintained its growth rate at 7.1 percent and moved forward.
“Over the last two years, India has seen a lot of change in terms of macro factors. We have seen an improvement in current account deficit and a fall in inflation and therefore a fall in interest rates. In general there were no external shocks. The global economy itself is coming out of the deflationary state and that has helped all the markets including India”, says R Sivakumar, Head Fixed Income, Axis Mutual Fund.
The global markets are on a rise. Both the emerging as well as developed markets have given very high returns over the last one year and investors feel that the fundamentals are in place. The S&P 500 index has returned 16 percent over the last one year.
Similarly, over the last one year, the Indian equity markets have returned 20 percent, making the country one of the top performing emerging markets across the world. Based on a MSCI list of emerging market returns for the last one year, India ranks eight among a total of 34 emerging markets.
But are these returns from the Indian market sustainable?
“We are being careful. We think that markets are over stretched in terms of valuation”, says Rajeev Thakkar, CIO, PPFAS Mutual Fund.
The historical or trailing P/E multiple of the Sensex is at 22.86. The last time the market traded at such high values was during the dotcom boom in 2001 - at 23 times. During the tech boom, some software stocks traded at P/Es closer to 100 times because there was a belief that these companies can grow faster than 100 percent over the coming few years and investors were ready give that premium to these companies. To back them, there was enough global liquidity in the market and India was riding on an American bubble in the dotcom stocks where companies without any profits were getting high valuation.
Similarly the boom in 2007 was again driven by the infrastructure sector and the P/E of the market was at 22.61 times. Interest rates had fallen and again there was a global liquidity rally. The entire market ended into a global financial crisis which started in the housing market of USA.
This time there is no sector boom. The entire bubble is now happening in the mid-cap and small cap sector and then stretching into the large-cap stocks. The BSE Midcap segment is trading at a P/E multiple of 31 times. “This is a very vulnerable segment. But we don’t know when and where the problem can start,” Thakkar says.
But to understand the market and its valuation, we looked at Price/Book value (P/BV) ratio. This is a ratio that tries to understand how companies are trading compared to the book value of the company. Book value is net-worth divided by the total number of shares. So if you have an asset worth Rs 100 giving a return of 18 percent, at what price are you willing to buy that asset? The higher the price you pay for that asset, the lower will be the return from that asset.
In September 2013, when Narendra Modi’s name was announced as a prime-ministerial candidate for the BJP, the Nifty 50 was trading at a P/BV multiple 3 times. The implied return on equity (ROE) of the market was at 16.46 percent. Investors were ready to pay a price/book value of 2.77 percent for that return.
In May 2014, the ROE was 18 percent and investors were ready to pay 3.5 times the book value for the same asset. This is logical.
Since the implied ROE went up, investors paid a higher price for these companies. Over a period the ROE of the Nifty 50 started to slide. By September 2016, the implied ROE fell to 14 percent and investors were still ready to pay a high price/book value at 3.5 times.
“ There is no way that this market can rise from here but chances are that there will be a time correction or worse, we can expect a nasty fall