Indian benchmark indices are currently experiencing a robust bull run, with the Nifty 50 achieving new record levels for the fourth consecutive week. On March 7, the Nifty soared to an all-time high of Rs 22,525. However, amidst the escalating market momentum and the anticipated pre-election rally, investors are growing increasingly wary of elevated valuations.
The valuation of the Indian equity market now stands as the third highest globally, trailing only behind the United States and Japan. Analysts are expressing apprehension regarding the market’s pricey valuation, highlighting concerns that the observed growth may not be fully supported by the fundamentals revealed in Q3 reports.
According to SBI Securities research, the Nifty50’s price-to-earnings (P/E) ratio currently stands at 18.1, positioning it after the US’s Nasdaq, S&P 500, and Japan’s Nikkei in terms of relative valuation. This places the Nifty50 at a forward P/E ratio of 18.1 times for FY24, exceeding its long-term average band of 15-17 times.
Comparatively, the US and Japan exhibit higher relative valuations, with Nasdaq and Nikkei trading at FY24 P/E ratios of 30.7 and 20.4, respectively. Rahul Arora, CEO of Nirmal Bang Institutional Equities, noted that while the market rally has been liquidity-driven, the fundamentals do not entirely support the current valuations.
Arora emphasized the importance of earnings in driving market prices, citing examples such as Nvidia and Dixon Technologies. While some stocks like Nvidia demonstrate a correlation between stock price and earnings, other segments of the market have witnessed prices moving beyond rational expectations, signaling potential excesses.
Liquidity Surge Propelling Market Valuations
Rahul Arora underscores the exponential growth of India’s mutual fund industry, ballooning from approximately Rs 5 lakh crore in 2016 to nearly Rs 55-60 lakh crore within a mere eight years. With equities comprising roughly 25-30 lakh crore of this total, and funds typically holding around three percent cash, the substantial dry powder available is staggering. Arora asserts that the era of significant corrections of 40-50 percent in stocks is a thing of the past. The current market liquidity is so abundant that even minor stock corrections are swiftly absorbed through aggressive buying.
Looking ahead, Arora anticipates that the momentum will likely persist amid this year’s elections, with a possible pause later in the year. Nevertheless, the prevailing liquidity in the markets is expected to continue driving valuations for the time being.
Sunny Agrawal, Head of Fundamental Research at SBI Securities, notes that the Indian equity market is trading at a premium compared to global peers such as the MSCI Emerging Market, FTSE, CAC, DAX, and Taiwan. However, Agrawal believes that India will maintain this premium valuation due to its relatively higher earnings growth (projected at 16.2 percent CAGR over FY23-25E), robust GDP growth outlook, political stability, and continuity in policies and reforms.
Looking ahead, SBI Securities identifies several key risks to this high growth trajectory, including the outcomes of general elections, the trajectory of US Federal Reserve rates, and geopolitical tensions.
Key Risks Impacting Market Outlook: General Elections, US Fed Rates, and Geopolitical Tensions
With the positive outcomes of recent state elections and a balanced interim budget for 2024-25, market focus has shifted towards the upcoming General Elections scheduled for April-May 2024. The imposition of the election code of conduct, effective from the announcement of the election schedule until the completion of the final voting phase, is expected to impede the execution of infrastructure projects that have been driving the economy in recent quarters. During this period, the government and public sector undertakings (PSUs) are unlikely to award fresh projects.
Regarding the US Federal Reserve’s rate trajectory, while the Fed has signaled a pause in rate hikes, the resilient US economy suggests that rate cuts may not materialize in the near term. Inflation data, employment conditions, and bond yields indicate that rate cuts are unlikely for the next 4-6 months. Market expectations of a 75 basis point rate cut in 2024 may diminish if the US economy continues to perform well and inflation remains elevated.
Geo-political tensions, particularly the ongoing conflict in West Asia, pose significant risks. The Red Sea crisis has disrupted shipping operations, resulting in longer delivery times for consignments and increased freight costs. This has led to delayed exports from India and threatens the country’s energy security. Additionally, the conflict has made Russian crude oil, previously sourced at lower costs by Indian refiners, more expensive due to heightened shipping and insurance costs through the conflict-affected Red Sea channel.
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