Stock markets slip into expensive territory once again

Bellwether index trading at P/E ratio of 22x; market cap to GDP at 81% is among highest in EMs

Propelled by better-than-expected corporate results in the October-December 2016 quarter despite demand shock from demonetisation and the ongoing rally in many global markets, Dalal Street, too, has seen a bull run.

The benchmark BSE Sensex index is now trading at 22x its trailing 12 months underlying earnings per share, which makes it overvalued on a historical basis. The Sensex price-earnings multiple had peaked at 19.8x before the market correction of early 2016.

In comparison, the five-year high valuation of the index is 23x reached in early July last year. The NSE Nifty 50 index is even more expensive at 23.4x - just a shade below its five-year high valuation of 24.5x reached in early August last year.

In comparison, the US Dow Jones Industrial Average is trading at 19.2x its trailing 12-month earnings, while S&P 500 is trading at 21.7x. Only commodity company-driven indices such as Brazil Ibovespa, UK’s FTSE 100 and Jakarta Composite index are more expensive than Indian indices now.

The Indian market looks even more expensive on market capitalisation to gross domestic product (GDP) ratio. The combined market capitalisation of all BSE-listed companies reached an all-time high of around Rs 118 lakh crore, as prices of many mid- and small-cap stocks made fresh all-time high last week.

“The benchmark index underestimates the exuberance in the broader market. The market capitalisation of all listed companies is now around 10% greater than the previous high despite no incremental improvement in corporate earnings or macroeconomic fundamentals,” says G Chokkalingam, founder & chief executive officer, Equinomics Research & Advisory.

The combined market capitalisation of all listed companies is now equivalent to 81.4% of India’s nominal GDP, the highest in emerging markets and up nearly 800 basis points from the level at the end of December 2015.

Globally, the market capitalisation to GDP ratio is the highest in the US, followed by the UK and Japan. Experts attribute the higher ratio in developed markets to the listing of large multinationals in these markets, which derive a significant part of their earnings from overseas markets unlike India, where listed companies are largely focused on the domestic market.

Dalal Street has witnessed one of the strongest bull runs in the past two months, with the exception of Brazil and Hong Kong markets. The benchmark BSE Sensex is up 8.5% since the beginning of the year, against a three to five% rally in most other markets.  

Analysts attribute the current rally to strong domestic flows besides the ‘Trump rally’ in the US and other emerging markets. “Rising inflation in developed countries along with the promise of Trump’s infrastructure spending has led to capital moving from bond markets to equity markets. Fund managers, who were sitting on cash, helped sustain this rally. After demonetisation in India, two things happened. Real estate lost its allure as a good investment destination, and interest rates on deposits fell sharply, owing to higher cash with the banking system. Both of these led to more money moving into equities and hence, this rally,” says Ritesh Jain, former chief investment officer of Tata Mutual Fund and founder of worldoutofwhack.com.

He expects the flows to sustain going forward but the risk of correction is rising, given the markets are in an overvalued zone. The outcome of the Uttar Pradesh elections, interest rate hikes by the US Federal Reserve and the various elections in Europe remain risks to equities.

Analysts say that mid- and small-caps are at a higher risk of correction, compared to large-caps. “The correction, which I think will come sooner rather than later, should be used aggressively to increase equity allocation,” says Jain.

According to Chokkalingam, a lot depends on the fourth quarter results, the trajectory of industrial production and GDP going forward. “There is no guarantee that corporate earnings would be as good in the fourth quarter as they have been in the third quarter. Besides, we foresee downward pressure on the index of industrial production and GDP growth going forward. All this would weigh on the markets. I am advising clients to play safe and move to relatively defensive large-cap stocks from mid- and small-caps,” says Chokkalingam. 

Valuation of world's major equity indices
Index	Country	P/E multiple	YTD index chg (%)
DOW JONES INDUS. AVG	US	19.2	5.3
S&P 500 Index	US	21.7	5.6
MEXICO IPC INDEX	Mexico	24.1	3.4
Brazil Ibovespa Index	Brazil	36.2	12.0
FTSE 100 Index	Britain	38.5	1.8
CAC 40 INDEX	France	21.0	0.6
DAX INDEX	Germany	18.2	4.1
Nikkei 225	Japan	22.8	1.3
HANG SENG INDEX	Hong Kong	13.6	9.6
Shanghai SE Composite	China	18.7	4.8
Nifty 50	India	23.4	9.2
S&P BSE Sensex Index	India	22.0	8.5
JAKARTA COMPOSITE INDEX	Indonesia	24.5	1.4
PSEi - PHILIPPINE SE IDX	Philippines	19.9	7.2
FTSE Bursa Malaysia KLCI	Malaysia	17.0	3.8
YTD: Year-to-date; P/E: Price-earnings ratio
Market cap to GDP ratio		(%)
Country	31-12-2015	Current
US	129.2	140.7
China	65.0	61.8
Japan	113.8	116.6
UK	119.3	127.0
France	80.0	80.7
Germany	55.4	56.8
India	73.8	81.4
Brazil	26.6	45.1
Indonesia	41.7	46.5
Mexico	33.1	33.0
Nominal gross domestic production at current prices in the past four trailing quarters
Sources: Capitaline, BSE, NSE, overseas market data as on Feb 22, 2017
Compiled by BS Research Bureau