Hold your horses: Equities are expensive but reasons are not enough to exit

The stock market rally since the beginning of 2016 has been extraordinary. At a time when the economy was reeling from extreme stress after the note ban, the stock market started rallying, with foreign investors buying stocks of over Rs 300 billion in March last year, the highest they have bought ever in a single month. The goods and services tax (GST) regime, which started in July, disrupted the economy further, but the stock markets were in a zone of their own as money kept coming. Retail investors, who began investing aggressively in mutual funds since 2014, kept oiling the liquidity in the market as they poured in Rs 1.8 trillion through the year.

The Sensex is up over 35 per cent since the end of 2016, while the BSE MidCap index is up 48 per cent and the BSE SmallCap by over 60 per cent. Corporate earnings recovery has been around the corner for three years, but is yet to materialise. The price-earnings multiple, a key indicator, puts the market in an expensive, overbought zone — signs of which are evident in the recent fall of many small- and mid-cap stocks from their stratospheric levels, though the large-caps continue their journey towards uncharted territories. Cocktail party conversations have moved on from war stories of multi-baggers to hushed conversations of when the party is likely to end.

A comparison with the heady bull market of late 2007 and the subsequent bear market keeps cropping up. However, there are clear differences between then and now. There were signs of possible dangers in the sub-prime market in the US and concerns of global growth, which isn’t the situation this time. The global economy is on a strong wicket. In India, there are no runaway capital expenditure plans, large-scale acquisitions, or mounting debt beyond the distressed companies. Bank credit growth to companies, which has been at a multi-decade low, is more likely to go up than stay at current levels. There are indications that a double-digit earnings recovery for the corporate sector is not far. Automobiles, consumer goods, private sector banks, non-banking finance companies, and even real estate stocks are doing well. If the government’s infrastructure spending rises, there are strong chances that private sector capex will start in the next 12-18 months.

It’s not that there aren’t risks to markets — the extent of increase in interest rates in the US will have a bearing on the risk premium on equities, and overall risk appetite and crude oil prices. Legendary global investors have called a bubble formation and have advised investors to shift their stance from aggressive to defensive. On the other hand, many Asia and India strategists are yet to talk about risks. For investors who are concerned about valuations, it could be a tempting choice to sell now and come back when prices are down, but this is easier said than done. Had this view been taken three months or even a month ago, investors would have lost some of the gains as the market has gone up since then. Also, equity as an asset class is likely to continue attracting new investors, given that there aren’t other avenues for wealth creation. Thus, investors are likely to be better off holding on to the bulk of their investments after booking minor profits. A small price correction should not be cause for concern, and a time correction (where prices don’t move much for the next few months as they adjust earnings and valuation) after the December quarter results is an ideal scenario.