Scaling new highs

Market valuations reflect optimism

India’s stock market indices have continued to advance, hitting new records. The National Stock Exchange (NSE) benchmark, Nifty 50, which has risen four per cent this calendar year, has hit new highs this week, while the BSE Sensex has touched the 75,000 mark for the first time. The market indicators are all reading green and there is little sign of nervousness at this point. The volatility index (VIX), which reflects spreads in Nifty option premiums and is considered a reliable sign of trading sentiment, is at its lowest level so far in 2024 — a sign that the market is calm and big price moves are not expected. Good daily trading volumes indicate strong participation, and stocks across multiple industries are trending higher. Retail flows into equity mutual funds continue to be strong — so strong, in fact, that some fund managers have restricted lumpsum inflows, and the regulator has issued advisories about “frothy” valuations in smaller stocks.

Foreign portfolio investors (FPIs) have been net buyers of equity in 2024, and they have also bought significant quantities of rupee debt. Domestic institutions (other than mutual funds) are also net-positive on equity. The Nifty’s price-to-earnings (PE) ratio, at 23, is on the higher side when compared with historical valuations, but well below the peak of over 30. The valuation is expected to come down as corporate results for the January-March quarter of 2023-24 are released and financials are updated to reflect new earnings data. The consensus estimates for the March quarter and full-year earnings are good. Management commentary and business updates are optimistic for the most part. Most high-frequency indicators also have positive values. Vehicle sales have been strong in 2023-24, railway and port freight traffic has grown, and power consumption has been high. Banks have seen a steep rise in credit demand. Taken together, all these fuel optimism for a sustained growth recovery.

The Reserve Bank of India (RBI) has also made encouraging statements. It expects the retail inflation rate to average 4.5 per cent in 2024-25 and growth to remain robust. However, the financial market may have to wait for rate cuts, which will come only after the RBI has met the inflation target on a durable basis. There are some danger signs as well. Mutual fund investors (mostly corporate treasuries) have pulled money out of the debt market. On balance, fewer shares have gained ground in March and April than those that have declined. A poor advance-to-decline ratio is often a sign of bull market peak. Geopolitical stresses have also triggered a rise in oil and gas prices, which is always a red flag for the Indian economy, given the country’s high import dependence.

There could also be some nervousness due to the upcoming general elections, whose results will probably be the next trigger for marketwide trends. Most of the investment community expects the Bharatiya Janata Party-led central government to return for a third term. If that happens, the market might be set for another big uptrend. A different result might conversely lead to a significant correction. The immediate trigger for the market would be the March-quarter results, which will soon start coming. Given the level of investor optimism, as reflected in the valuations, there might be little scope for corporate underperformance in the near term.