'Frothy' assets spark concerns as cash floods Indian markets

From officials of India’s central bank and the market regulator to fund managers, people are fretting over elevated asset prices.

The nation’s equities and bonds have rallied even as economic growth sags to its weakest since 2014, and earnings remain stubbornly weak. The reason: A surge in local flows after last year's cash ban and buoyant global markets.

This divergence is spiking valuations and inciting caution among authorities and strategists. Michael Patra, a member of the Reserve Bank of India’s rate-setting panel, described the conditions as “frothy and bubbly” in the minutes of last month’s meeting. Gurumoorthy Mahalingam, a board member at the Securities & Exchange Board of India, said on September 6 that large inflows need calibration at a time when the rupee is strengthening.

“The combination of high valuations in equity and fixed-income markets, an appreciating currency and the persistence of a liquidity overhang in the money market is a perfect recipe for a financial imbalance,” Patra was quoted as saying.

Investors seem to be placing the most faith in a market characterized by anaemic profits. The NSE Nifty 50 Index is up 31 per cent this year in dollar terms, versus a 28 per cent climb in the MSCI Emerging Market Index.

The expansion in developing-nation's stocks is backed an increase in company earnings. The outlook for Indian businesses, though, has been muddied by the slowdown in growth caused partly by the cash ban and the disruption triggered by the new sales tax introduced on July 1.

Earnings per share growth at Nifty members will settle at “mid-single digits” in the year to March, versus consensus expectations of 11 per cent, Credit Suisse Securities India’s equity strategist Neelkanth Mishra said in Mumbai last week. Projections of a 23 per cent rise for the next financial year may see “harsher cuts,” he said.

Despite the earnings decay, the Nifty’s estimated price-earnings ratio is almost two standard deviations above the 10-year mean. The last time the ratio was that high, at the start of the global financial crisis in 2008, the gauge had its worst annual decline on record.

Strong flows have kept multiples elevated and made it hard for managers to spot winners. Local funds bought a net $11.5 billion of shares so far this year, exceeding the all-time high purchases of $11 billion in 2015. Foreigners have plowed $6.8 billion into equities and bought $23 billion of debt since January 1.

“We’ve seen micro cap-oriented funds closing subscription, which highlights that there is overvaluation in the segment,” said Harsha Upadhyaya, chief investment officer for equity at Kotak Mahindra Asset Management Co.

Investors have embraced financial assets with gusto after the currency ban took the shine off property and gold. Stock funds took in a record Rs 20,300 crore in August, data from the Amfi show. 

Funds that hold both equities and bonds got Rs 38,900 crore in the first five months of the year that began April 1, four times more than in the year-earlier period.

In debt, relatively higher real yields have drawn global investors. The nation's 10-year sovereign bond yields 6.60 per cent, the most among major Asian markets. "This means in India investors are getting decent compensation beyond inflation protection," said Vivek Rajpal, rates strategist at Nomura Holdings Inc. in Singapore.

Foreigners have lapped up all available limits for corporate debt, driving down yields on top-rated 10-year bonds nearly 70 basis points from the year's peak seen in May.

That isn't to say that the entire debt space is overheated, according to Lakshmi Iyer, chief investment officer for debt at Kotak Mahindra.

"Bond markets are nowhere near a bubble," Iyer said. "There could be pockets of mis-pricing," she said, referring to triple-A rated debt.

Financial-asset prices could be an useful input in monetary-policy making in India, according to Rohan Chinchwadkar, professor of finance at the Indian Institute of Management at Trichy in southern India. Central banks like the US Federal Reserve and the Bank of Japan keep an eye on markets for cues on decision making.

"Asset prices and financial variables provide valuable information about the economy and incorporating them into the monetary-policy framework can help the RBI stay ahead of the curve," he said.