Indian stock markets are on a sustained rally this year and have gained strong since January right after the plunge of November-December, following demonetisation. Benchmark equity indices Sensex and Nifty have risen 22%-24% so far in this year, widely outperforming other major stock markets in the world. Domestic markets have also seen a few milestones this year, including Nifty crossing the five digit mark of 10,000 and Sensex nearing 32,700 points for the first time.
Despite this stellar show in Indian equities, the stock market might be on the verge of a major correction, which might be as bad as the 2008 financial crisis. In the year 2008, the 30-share barometer Sensex plunged 27% over the month of September to 9,748.08 points from 13,417.91 points. Later in a six-month period from March to September 2009, the Sensex more than doubled to 16,741 points from a level of around 8,325 points. We take a look at five warning signals which tell India’s stock market may be close to a 2008-like crash.
Stagnant earnings trail market surge
Earnings growth have languished in the last three years but the markets and stock prices have continuously risen. Earnings per share at companies in the NSE Nifty 50 Index have stagnated since the run-up to the 2014 elections, which triggered a surge in equity prices, Bloomberg said in a report last week, adding that the index has risen 50% over the same period.
The risk is that projections have been too optimistic. Earnings at NSE Nifty 50 Index constituents have trailed consensus forecasts for most of this decade, the Bloomberg report said. “It is a liquidity-driven rally, and there might be a hard landing, especially if the second quarter earnings disappoint, Yogesh Nagaonkar Fund Manager – PMS, Bonanza Portfolio Ltd told FE Online.
Fund managers say that the markets are rallying simply because of their being too much liquidity in the system without the underlying fundamental factors to support it. “Equity Mutual Funds are at over 6% cash holding now, which is high. A lot of foreign investors have already exited the market,” Yogesh Nagaonkar said. “It’s a typical bull market and there is huge liquidity with a lot of money flowing into Mutual Funds,” he said, adding, “Now, when the mutual funds start selling, markets will crash, as there will be no one to buy.” One other investor chose not to mince words. “Markets are heating like a tinderbox, complacency is at the highest level you will see,” Sanjiv Bhasin, Executive Vice President at IIFL said in the last week’s Bloomberg report. “This is the time to start smelling the coffee,” he added.
This year has emerged as a record-breaking one for the IPO (initial public offerings) market. About Rs 50,000 crore has been raised through the public offers so far since January 2017, and several others are slated to come up with their public issues. Nine years ago, 2008 was the year that, many hoped, was going to be the year of mega IPOs. The stock markets were rallying to new highs, and Reliance Power‘s IPO was oversubscribed 73 times. But, the company’s shares slipped on the listing on 11 February 2008, and so did the Sensex by 834 points.
This year is also being touted as the year of IPOs. Some have even entered the exclusive club of the companies mobilising over Rs 1 lakh crore and several issues have been oversubscribed by more than 100 times, even at higher valuations. The reason: High liquidity in the market, perhaps, due to demonetisation. “A lot of IPOs are being sold at crazy valuations, with a lot of exuberance. It’s not sustainable,” Yogesh Nagaonkar said.
Indian equities have been rallying since January 2017 even as economic growth has slumped to its weakest since the year 2014 and most companies reported lower-than-expected first quarter earnings. Despite the earnings decay, the Nifty’s estimated price-earnings ratio is almost two standard deviations above the 10-year mean, another recent Bloomberg report said. This means the valuation of Nifty measured in terms of price-earnings ratio is exceptionally higher than its 10-year long-term average. 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.
GDP under stress
India’s GDP growth plunged to a three-year low in April-June, slowing down to 5.7% in first quarter of FY 2017-18 and disappointing for the second straight quarter. The 5.7% fiscal first-quarter GDP growth, of an economy desperately trying to recover from the shocking impact of demonetisation, was much lower than the 7.9% seen in the same quarter a year ago. It even slowed down from 6.1% in the preceding quarter.
Brokerages have been expressing caution over Indian market that it is overvalued and is trading at close to 20 times one-year forward earnings, well above its long-term historical valuations of around 15 times. “There is a clear and present risk to the earnings turnaround in FY19 as consumption, which has been the sole driver of growth, will not likely be strong enough due to weak fiscal push and job growth. The capex cycle remains nascent and limited to pockets of infrastructure,” Macquarie said in a report in September 2017.