Valuations shoot up despite note ban, GST and other factors in last decade

Massive polarisation as only a few stocks outperform handsomely

Indian markets witnessed turbulence in the past decade owing to certain major events and structural reforms such as demonetisation, the implementation of goods and services tax (GST), the collapse of some big businesses, and so on. It’s no wonder then that the S&P BSE Sensex and the Nifty50 grew at a 9 per cent compound annual growth rate (CAGR), a mediocre return given that inflation was high in the first five years of the decade. 
 
However, the indices representing mid- and small-cap stocks delivered between 5 and 8 per cent growth during this period. And though the markets have evolved and investors have become wiser, certain risks are currently being overlooked.
 
The last decade followed the global financial crisis, which started in 2008 with the collapse of the US-based Lehman Brothers. The consequent liquidity squeeze forced central banks to pump in sizeable funds to buy bonds from companies in their countries — a move called quantitative easing (QE). This was a defining development, wherein interest rates were cut to near zero, making money a ‘cheap’ tool to pump-prime economies.
 
“The last 10 years have been an abnormal period for global equities, with very consistent and correlated rallies. Moves across global equity markets have been determined by the monetary policies of central banks, rather than growth trends,” says Sanjay Mookim, India equity strategist, BofA Securities.
 
However, globally, economies don’t seem to be out of the woods yet. An indicator of this is the way the US economy faced a slowdown after the Fed withdrew QE and raised interest rates.
 
Indian markets, too, benefited from liquidity infusions even as economic and corporate earnings growth slowed. As Mookim points out, “Indian equities are going up even though the economy is weak.” However, major events and structural reforms have caused significant intermittent corrections.
 
Since these events had an adverse impact on a large section of society, especially the informal sector, it has also restricted earnings from the stock market. Sensex earnings have de-grown in three of the last five years and posted an average earnings growth of 1 per cent over the last five years.
 
“At its peak in 2008-09, earnings from the stock market as a percentage of GDP was 5.6 per cent, which has fallen to an all-time low of 2.7 per cent. In the US, it’s up from 7.1 per cent to 13 per cent,” says Shiv Saigal, deputy CEO, capital markets advisory, Edelweiss Financial Services.
 
This collapse of earnings is the reason Indian equities have lagged behind their global peers. This, together with the big disruptive events such as demonetisation, GST, a slowdown in real estate, the liquidity crisis, and others have been partly responsible for the slower job creation and consumption.
 
Again, the fear of getting trapped in low-quality, low-growth or debt-heavy companies is responsible for the polarisation in the markets, leading to multi-year high valuations of select stocks. Among the 50 Nifty stocks, 28 are trading above a PE ratio of 20 times; within these, 14 are trading between 30-81 times.
 
“Investors are now putting great emphasis on the quality of corporate governance, management, auditing and balance sheets. Consequently, markets have become polarised in favour of a few stocks,” explains Gautam Duggad, head of research – institutional equities, Motilal Oswal Financial Services.
 
Markets have also become more liquid as there are now more stocks/sectors to invest in. Within the financial sector, for example, there are asset managers (AMCs), life and general insurers, brokerages and non-banking finance companies. The consumption list now includes discretionary plays, quick service players, multiplexes, retailers, etc.
 
Experts agree that investors and markets are turning smarter. “Investors, Indian and foreign, have become more knowledgeable. There is a lot more depth in the research and analysis being done,” says Mookim.
 
Another indication of investors becoming more savvy is that the monthly contribution of SIPs (systematic investment plans) has grown from about Rs 2,000 crore 5-6 years ago to an average of Rs 8,000 crore in the past 18 months, even as GDP growth has halved to 4.5 per cent.
 
“In the last 7-8 years, the colour of institutional equity flows has shifted disproportionately in favour of domestic investors. Between 2006 and September 2019, the total domestic institutional equity inflow was $55 billion. Of this, $45-46 billion has come after 2014 through SIPs and lump-sum investments. This means retail investors are maturing and are not hostage to market fluctuations,” says Duggad. “Earlier, investors came during euphoria and sold during despair. That is not happening anymore. That’s a very positive development,” he adds.
 
“A lot of money has come into passive funds and quality names, instead of the earlier ‘word of mouth’ investing method,” says Saigal.
 
The emergence of alternative investment funds, real estate investment trusts, infrastructure investment trusts, and the surge in the assets of portfolio management services show investors’ appetite for risks and new products.
 
With more sovereign wealth funds, family offices, life and general insurers, and pension funds, markets have also become efficient and are in stronger hands now.
 
The downside clearly lies in the earnings. “We would see earnings downgrade in FY21 as well, simply because expectations are unrealistic. Markets have gone up because of global factors. But are earnings downgrades sufficient to correct the markets? I’m not so sure,” says Mookim.
 
The other risk could emerge when markets shift from the ‘growth’ to ‘value’ theme. If investors are not nimble then, they could be caught on the wrong foot.
 
The global trade war could be another defining moment. Though the first phase of the US-China trade war may be ending, it potentially marks the reversal of the multi-decade ‘globalisation’ theme.
 
In the short term, Indian markets may stay choppy as the country’s GDP and corporate earnings are expected to recover slowly. In the long run, while some existing companies/sectors will remain leaders, new ones could join the party. Experts also hope that gains will be more visible across markets.
 
“We haven’t had any advantage of demographics so far. But when we move from a $2.7 trillion economy to a $5-plus trillion one, markets will reflect that with some segments (financialisation of savings, emergence of more consumption segments, lifestyle spending, etc) rewarding shareholders disproportionately,” asserts Duggad.