D-Street over demonetisation? Sensex valuation back to pre-note ban levels

Index is trading at 21.3x its underlying trailing 12-mth earnings, against 20.9x on Nov 8 last year

Pushed by domestic investors, the Dalal Street has overcome the demonetisation blues, with the benchmark BSE Sensex valuation back to pre-currency swap levels, notwithstanding the worries of a slowdown in gross domestic product growth and corporate earnings. 

The benchmark index is now trading at 21.3x its underlying trailing 12-month earnings per share, slightly higher than the 20.9x at the close of trading on November 8 — the day demonetisation was announced. After the invalidation of high-value currency notes, the index valuation touched a low of 20.1x on November 24. The index is, however, around 300 points or one per cent lower, compared to the closing price on November 8. 

The recovery has been entirely led by domestic investors, who have matched most of the sales by foreign institutional investors (FIIs) in the past two months. For example, FIIs sold shares worth Rs 32,445 crore between November 9 last year and January 19, 2017. During the same period, domestic institutional investors, including mutual funds (MFs) and insurance companies, made fresh investments worth Rs 26,316 crore, according to the data of the Securities and Exchange Board of India (see adjoining chart). MFs have been the biggest buyers, pumping in Rs 22,630 crore in the equity market during the period. Experts attribute this to a steady inflow of funds under the systematic investment plans (SIPs) despite market volatility. According to industry estimates, SIP inflows are around Rs 4,000 crore a month currently and growing. 

Some experts say the equity market has been an unintended beneficiary of the cash crunch induced by sucking out 86 per cent of India’s currency in circulation. “After demonetisation, many investors were forced to cut their discretionary expenses due to non-availability of cash in the banking system. Many investors put in this ‘surplus’ cash in equity MFs or made direct investments in the secondary market,” said Dhananjay Sinha, head-institutional equity, Emkay Global Financial Services.

 

 

There is some truth to this. MF investments in equity were up 50 per cent on a month-on-month basis to a 12-month high of Rs 13,775 crore in November – the first month of demonetisation when cash crunch was at its worst. The flow of MFs moderated to Rs 9,179 crore in December and has since slowed down further to Rs 2,670 crore till January 18.

The bullish stance of domestic investors is, however, not matched by the underlying fundamentals of Corporate India. The rise in index valuation has not been matched by higher corporate earnings. The underlying earnings per share (EPS), which represents the combined net profit of Sensex 30 companies, declined 3.2 per cent during the period, from Rs 1,321 per unit of the index on November 8 to Rs 1,282 at the close of trading on January 19.

“Domestic investors, including retail and high net worth individuals, have been bullish on the market for nearly three years now. And nothing has changed in the recent months to change that, including demonetisation and sell-off by foreign investors,” said G Chokkalingam, founder and chief executive officer, Equinomics Research & Advisory.

The decline in the Sensex EPS is largely due to poor corporate earnings during the July-September 2016 quarter and many companies, including index heavyweights, reported their second quarter earnings after November 8. The Street expects Corporate India to report better numbers in the third quarter, led by energy and commodity producers.

Sinha expects MF flows to normalise, as cash crunch eases and individuals once again start spending. In the first 10 months of 2016, MFs invested an average of around Rs 2,500 crore a month in the equity market. This jumped to around Rs 8,700 crore in the past three months of 2016 and January 2017 so far.

This raises the possibility of the market once again coming under pressure, if FIIs start pulling out money in a big way. “Despite recent improvement, domestic investors are in no position to counter FII outflow, given the nearly $350-billion worth of cumulative investment by the latter in the market. A big sell-off by foreign investors could lead to a sharp correction in the market,” added Chokkalingam.