Dalal Street is waiting for new triggers for the market rally to continue. Valuations in the banking and financial segment, at the fore of the rally, are at an all-time high, limiting further upside in the near term. Market players say now, top companies in underperforming sectors such as information technology, consumer goods, oil and gas, power, telecom and metals should start delivering to take the market to new highs.
The top 15 banking and financial companies are trading at a 10-year high valuation of 18.1 times their trailing earnings and 2.3 times their latest book value. Together, financial stocks account for 30 per cent of the Nifty, against 24 per cent a year earlier and the previous high of 27 per cent (in March 2013). These stocks include State Bank of India, ICICI Bank, HDFC, HDFC Bank, Axis Bank, Punjab National Bank, Canara Bank, Bank of Baroda, YES Bank, IndusInd Bank and IDFC.
Through the past 12 months, the Bank Nifty has risen 55 per cent, outperforming the benchmark Nifty, which is up 33 per cent.
“Further upside in financials is limited. Other heavyweights in sectors such as oil and gas, capital goods and metals should start contributing to take the rally forward,” says a senior analyst at a city-based brokerage firm. “Such high exposure to a single sector is a risk to the market in the near term, as a correction in the stock prices of banks and financials will pull down the overall market even if other stocks do well.”
In the past, such peaks have been followed by periods of under-performance by banking and financial stocks. Overall, however, financials have been out-performing the broader market since early 2007, resulting in a steady rise in their index weight. In March 2006, financials accounted for 17.6 per cent of the Nifty companies’ combined free-float (non-promoter) market capitalisation.
Many say financials and other high-beta stocks could be hit first if foreign capital inflows to India decline. “Banking and financial stocks have been the biggest gainer of the strong FII (foreign institutional investment) inflow into India. If the trend reverses or the flows moderate, it could adversely affect valuations in the sector and pull down the broader market,” says Dhananjay Sinha, head (institutional equity), Emkay Global Financial Services.
In the past year, pharmaceutical companies, too, have been a net contributor to the market rally, outperforming the broader market. The National Stock Exchange pharma index has risen 63 per cent in the past 12 months, helping the Nifty touch a new high during the year. The top four pharma companies in the country account for 6.4 per cent of the Nifty, against 5.9 per cent a year earlier and 2.3 per cent five years ago.
Analysts attribute this to the strong operational and financial performance of Indian pharma companies on the back of higher exports to the US.
The steady rise in their stocks through the past five years has led to concern a slowdown in capital inflows could lead to a correction in these stocks.
Some, however, say there is further upside in sectors that have outperformed the benchmark indices. “Banks and NBFCs (non-banking financial companies) are proxies for the economy and their financial performance will only improve from here, given the likelihood of a pick-up in the capex cycle and growth in gross domestic product,” says Devang Mehta, senior vice-president and head (equity sales), Anand Rathi Financial Services.
Others are banking on the services sector. “India is a services sector-oriented economy and this segment continues to do well despite difficulty in the industrial sector. Financials are a good proxy for the growth of the Indian services sector. I expect banks and financials to lead the market going forward,” says G Chokkalingam, founder and chief executive of Equinomics Research & Advisory.
Even if that is the case, investors in financial stocks will be better off hedging themselves against a sell-off in the sector.