Riding on sentiment

Bank recapitalisation is a fillip for the markets

The announcement of the bank recapitalisation plan has imparted new momentum to the stock market rally. Importantly, it seems to have led to a change in the attitude of foreign portfolio investors (FPIs). They were net sellers in equities to the tune of Rs 5,279 crore between April and September, and sold Rs 6,500 crore in October before bank recapitalisation was announced on October 24. But the very next day, they pumped in a mammoth Rs 6,800 crore and continued to buy, parking over Rs 10,000 crore in Indian equities in the last five sessions. The FPI sentiment reversal has been a major contributor to the rally and the major market indices have moved up by 3 per cent since the bank recapitalisation announcement. 

The public sector banks (PSBs) have experienced unreal surges in buying volumes and prices. At the same time, there was some selling in high-rated private banks, which continue to remain overvalued. The enthusiasm spilt over into other sectors as well. There has been a shift in domestic asset allocations, too, with some money moving out of the bond market and into equity. The bond market has seen some rise in yields partly due to the Reserve Bank of India’s latest policy review, which suggested that the central bank would not cut policy rates in a hurry. However, bond investors also fear a crowding-out effect when the Rs 1.35 lakh crore of bank recapitalisation bonds are placed on offer. Some investors are also speaking of a possible rise in inflation expectations as and when bank credit expands substantially. 

This steep rally coming on the back of already high prices has led to fears that the market may have overheated considerably. Although corporate results for the second quarter have been better than expectations so far, analysts are speaking in terms of a mere 7-8 per cent rise in earnings, year on year. This is far better than the last couple of quarters, though it is difficult to justify a price to earnings ratio of 27, which is the average valuation of both the Nifty and Sensex. It is even more difficult to justify a price to book value ratio greater than 3 for bank stocks in any market, and India's private banks include several such highly valued institutions.

Optimists cite the fact that India has a low market capitalisation relative to its gross domestic product and, therefore, equities could travel further north. There is also the likelihood that the next two quarters will benefit from a low base effect since the second half of 2016-17 saw weak corporate performances. Finally, there are hopes that the transient but severe effects of demonetisation are dissipating and the implementation of the goods and services tax may be settling down. In that case, there could be a growth spurt. However, it will have to be a big rebound to justify current valuations. Alternatively, there may be a sober evaluation once the details of bank recapitalisation are released. Overall, the market sentiment is, in itself, an important variable and it has certainly improved after the recapitalisation plan was announced. Given the substantial retail participation in this rally, it could help create a wealth effect that translates into higher consumption.