The Indian equity markets’ record breaking trail may continue in the near term, as the European Central Bank decides to embark on a much awaited monetary easing exercise.
Historical data shows that the Indian market has almost always reacted well to key easy liquidity measures carried out by global central banks. ECB’s latest decision to make monthly bond purchases of 60 billion euro till end of September 2016, may see the benchmark indices powering ahead, in an extension of a rally that has breached all previous records. On Thursday, ECB president Mario Draghi said that the expanded asset purchases will begin in March and run through end of September 2016. Ahead of this announcement, both the 30-share Sensex and the broader Nifty observed record closing of 29,006.02 and 8,761.4, respectively.
While not all three cycles of liquidity infusions by the US Federal Reserve (termed as quantitative easing) benefited emerging market equities throughout their existence, the MSCI India index has always fared well in the first three months of the decision. The premise is true for all but one infusion cycles carried out by US and Japan since 2008.
In the latest instance, after the Bank of Japan (BoJ) in October 2014 said that it will expand its monetary base to 80 trillion yuan by purchasing government bonds, equity ETFs and real estate investment trusts (REITs), MSCI India has added more than 3% while both MSCI EM and MSCI world (representing developed markets) have lost 1% to 3% of their values. The Indian market has received $3 billion worth of foreign portfolio investment (FPI) during the period.
However, this time around, high valuations of the Indian market may be a deciding factor in its performance going ahead. Currently the Sensex is trading at 18.4 times its one-year forward earnings potential, compared to a ten year average of 15 times, depicting a premium of more than 20%.
Although the valuations may appear high given the retreating earnings expectations from Indian companies in FY14-15, given that most investors regard Indian as a preferred play in the emerging market universe due to its growth potential and reformist government, it may not be surprising to see valuations stretch further hereon.