Nifty feat gives rise to fear of a stock market bubble

By Jatin Bavishi

Although the motif of the classic The Great Gatsby appears to be a thwarted love story, it incidentally encompasses a highly symbolic theme of prosperity (and its eventual decline) in the 1920’s for Americans, often eulogised as the ‘Roaring 20’s’. A large part of it was due to investments made by common people on the ‘bourses’. Sadly, the market collapsed in 1929 which resulted in the Great Depression. On the 24th July 2017, the Nifty-50 stock Index of India achieved a historic feat of 10,000. Is this our own version of the 1920’s?

What caused the rise?

As a result of excess liquidity pumped by Central Banks, foreign investors are lured to Emerging Market Economies (EME’s) along with the prospect of higher returns, a weaker dollar and low oil prices. While they have played a role in the rise in Nifty, we must look at the set of domestic factors as well.

The most important being the optimism among investors in India’s growth story. The IMF and other international agencies have estimated growth to remain above 7% in 2018 against a slew of business friendly reforms. The NSE Volatility Index (VIX), a proxy for investor’s perception of volatility in the market, is hovering around 10, which is lower than the 10-year average, suggesting confidence in the economy. Successful passage of Goods and Services Tax (GST) is being hailed as an important landmark in the rally.

Reliance Industries Limited (RIL) and HDFC have been the darling among investors. Healthy profits by the former, particularly in its oil business and rationalization of tariffs of its telecom initiative, Jio, helped the cause. HDFC registered buoyancy in profits after Securities and Exchange Board of India (SEBI) clarified its position on Participatory Notes (P-Notes), which are short term instruments used by foreigners to invest in India without registering with the regulator.

There has been a systematic loosening up of financial markets. Employees’ Provident Fund Organization (EPFO) got approval in May 2017 to invest up to 15% of its corpus in Exchange Traded Funds (ETF’s) and Life Insurance Corporation (LIC), India’s largest Domestic Institutional Investor (DII) has expanded the share of equities in its portfolio.

An important part of the rise was led by Mutual Funds (MF’s). MF’s are a popular savings instrument for largely risk averse Indians who want to bet safely. In April 2017 alone, inflows via MF’s to equity were over 4200 crores, reports The Economic Times. All of this is likely to have poured in colossal liquidity in the system.

The sceptics speak

Some investors, however, do not share the enthusiasm of their bullish counterparts. The Price-to-Earnings (PE) Ratio (price paid to earn one unit per stock) of Nifty stood at 17.9, the highest in the last nine years. For these sceptics, this is indicative of a bubble. Despite growth prospects, poor industrial production and tepid credit growth are seen as heckling factors.

Incidentally, our share market is the second costliest in the world, behind Standard and Poor (S&P) of the USA. The divergence between index level and volatility (VIX) is seen as a sign of complacency.

The inflow is also a result of a virtual drying up of all other avenues of investment. In the last one year alone, Nifty has given a return of 21% to its investors. This, in comparison to 8% returns on Small Saving Instruments (SSI), 7% on Fixed Deposits and crucially, (-) 10% on gold. According to an analysis done by an independent media agency, this TINA (there is no alternative) is as important a factor as liquidity and optimism.

Are we safe for now?

Following the phenomenal innings, fund managers have now adopted a more careful approach. In June 2017, top Mutual Fund managers decided to sit on piles of cash hoping for markets to oblige them with a correction (average cash holding was at 5.7%). Clearly, the price-earning ratio is afflicting these managers. A recourse is offered by other ratios, like book valuation (value of a security asset as entered in the firm’s books) which was at 3, compared to 6, which was recorded in the last bullish phase.

Stock indices are very sensitive to information, and it would not be all unwise to expect some decline in their values. However, in the short run, the Indian markets are relatively well-placed to absorb a shock. Moreover, there are ample opportunities in sectors which have not participated equally in this spree, such as the public sector, Fast-Moving Consumer Goods (FMCG), IT, and some pharma companies.

Featured Image Source: Visual Hunt