Why Markets are cheap now

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The value of the companies listed on the stock exchanges will always have some relationship with the total output in the economy. The value of the companies listed on the stock exchanges will always have some relationship with the total output in the economy.
SummaryOverall market capitalisation trading near the lower end of historical band

There is much fascination around the levels of the Sensex and the Nifty. The two markets are today near their highs and the general belief is that the markets are expensive, have moved up too sharply and should correct, going forward. Around two months back we saw a series of reports from FII brokerages projecting the Nifty to be at levels between 5,600-5,900 a year from now. The actual market move has taken most people by surprise. I still believe that the markets are cheap and will give strong returns over the long term. There are three main reasons for it.

The market capitalisation-to-GDP ratio is near the lower end—the value of the companies listed on the stock exchanges will always have some relationship with the total output in the economy. Ideally, as the economy grows the market capitalisation will also grow. However, these moves tend to be in cycles; where there is a cycle of huge gains, where this value goes much higher than that can be justified, and then there are cycles of loss in value. The market capitalisation of companies on the BSE peaked out in January 2008 at a level of Rs 75 lakh crore. In that year the GDP of the country was Rs 50 lakh crore thus giving a market cap/GDP ratio of 150%. Incidentally, when the move started in the year 2003 this level was as low as 45%. Over the last five years the GDP of the country has grown and the estimates for this year are at Rs 112 lakh crore. However, the overall market capitalisation stands at just Rs 68 lakh crore thus giving a market cap/GDP ratio of 60%. Now if we break down the drivers of the markets in the current up move they have been largely stocks from the FMCG, IT and pharmaceutical industries. The move in the IT and pharmaceutical industries has been largely due to the export market, as most of their profitability comes from there and as such has not been driven by the domestic economy. Today in the Nifty these companies have nearly

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