Bull run pushes market valuations to 10-year high; Nifty ends at 10,800

After 5 consecutive days of gains, the Nifty 50 index on Tuesday ended at 10,800, its highest close since March 6-before India imposed lockdowns and the economic went through a virtual halt

The benchmark indices may be 13 per cent below their all-time highs reached earlier this year, but their valuations have climbed to 10-year highs. The surge — the Nifty50 index is up 42 per cent from its coronavirus lows — coupled with a deterioration in earnings estimates, has seen the indices swing from ‘cheap  to ‘expensive’ territory within a matter of months. Such a dramatic shift in the market dynamics has stunned many on the Street.

After five consecutive days of gains, the Nifty on Tuesday ended at 10,800, its highest close since March 6. While the markets have ­rebounded (numerator: price), the consensus analyst estimates have seen deep cuts (denominator: earnings), pushing the indices above their long-term averages. 

The Nifty is currently trading at 20 times its forecasted earnings over the next 12 months — most since at least 2010. Also, the Nifty price-to-earnings (P/E) ratio is above its long-term average of 16.5 times.

“Following the recent rally, the Nifty is trading at 19.8 times one-year forward earnings, the highest multiple in the past decade. The spread between the earnings yield and the bond yield has narrowed, and is now within a fair value zone. With a continued increase in Covid-19 cases and slower economic growth, we remain selective,” said Saion Mukherjee, head of India equity research at Nomura, sounding a caution to investors.

Since April, the markets and the earnings estimates have moved in opposite directions.

“The consensus earnings estimates for FY21 are down 27 per cent since the start of FY21. The extent of earnings cuts is steeper than seen during the global financial crisis and, as expected, much steeper than previous years. Earnings for FY22 are also down 16 per cent since April,” said Mukherjee. The current valuations look even more expensive — some peg them to be at all-time highs.

This is considering the further downside risks to earnings.

Analysts think corporate earnings will decline 2 per cent in FY21 and grow 35 per cent year-on-year in FY22. “While earnings are difficult to predict in the near term, it remains to be seen if consensus can be right in FY21 and FY22 after six consecutive years of significant overestimation,” said Varun Lohchab, head of institutional research at HDFC Securities.

A large part of the recent gains is fuelled by easy global liquidity underpinned by aggressive stimulus measures by global central banks.

“This is a liquidity-driven global rally, which has taken valuations the above long-term averages. Also, the opportunities to invest in other assets are shrinking, pushing demand for equities,” said Abhimanyu Sofat, vice president (research) at IIFL.

So what explains investors’ appetite for stocks at these expensive valuations even as the earnings environment remains uncertain? “We believe the market is looking beyond FY21 earnings, and (investing) on a two-year forward basis,” said Mukherjee. However, even on a two-year forward basis, the markets look expensive. The Nifty trades at 15.6x its 24-month forward estimates compared to the long-term average of 14.4x.