Stocks listed in India have turned quite volatile of late due to the weakening rupee. But despite the currency’s decline since mid-August, the Sensex is up around 11 per cent and the Nifty around 9 per cent since the beginning of 2018. Investors have, however, been quite uneasy over the last few months, despite the rally in benchmark indices.
This is because mid- and small-cap stocks have been walloped since February. The BSE midcap index is down around 9 per cent so far this year while the BSE Smallcap Index is down 12 per cent. A spate of governance issues in smaller stocks, selling by mutual funds in order to adhere to the revised fund categorisation norms and profit booking by investors were some of the reasons for the under-performance of mid- and small cap stocks.
Of the 3,200 stocks actively traded on the BSE, around 77 per cent have recorded price decline since January 2018. More than 500 stocks have lost half their value and around 1,300 stocks have lost over 30 per cent of their value in this period.
Contrary to global trend
The Indian benchmarks — the Sensex and the Nifty — also managed to trump all their global peers. With the sole exception of the Nasdaq Composite Index, that has risen 15 per cent in 2018 due to the upbeat sentiment towards technology stocks such as Amazon, Apple and Alphabet, Indian benchmarks have outperformed all their global counterparts.
Sentiment in the global equities market has been roiled by the trade war initiated by Trump, dollar strength due to monetary tightening by the Federal Reserve and rising crude oil prices. Foreign investors have turned bearish towards emerging market equity in general, with Asian countries such as Indonesia, Malaysia, Philippines and South Korea witnessing strong fund outflows this year.
The Indian benchmarks have been able to put up a strong show despite these headwinds thanks to the continuous flow of money from domestic mutual funds. With the universe of investible stocks limited for large institutional investors, they have been chasing a handful of larger stocks, thus resulting in an irrational rally in the Sensex and Nifty.
Valuation not comforting
With the unrelenting rise in stock prices, valuations in the Indian market have become uncomfortable. The Sensex currently trades at trailing 12-months PE multiple of 24.5. This is higher than the five-year average PE multiple of 20 times and close to the upper end of the PE band, of 25. The BSE mid- and small-cap indices are far pricier, trading at PE multiples of 37 and 54 times earnings respectively.
Valuation in select sectors, which have been witnessing sharp price increases have also seen valuations rise sharply. For instance, the BSE FMCG index currently sports a PE multiple of 54 times, due to investors chasing stocks such as ITC and HUL. This index has gained 12 per cent so far this year. Consumer durables stocks are also currently trading at very high PE multiples.
Few sectoral gainers
It is also apparent that the rally this year has been led by a handful of sectors. Information technology stocks, led by TCS (up 58 per cent since January), Tech Mahindra (up 48 per cent) and Infosys (up 44 per cent) are among the top gainers this year. A depreciating rupee is seen as a positive for these companies that largely garner revenues from overseas in dollars. The BSE IT Index is up 41 per cent since the beginning of this year. Other sectoral gainers are FMCG, Healthcare and Banks. While continuing consumer spends in urban and rural India are perceived as a positive for FMCG stocks, investors decided to bargain-hunt among beaten-down stocks in the healthcare and banking sector.
Barring the above, though, all other sectoral indices have recorded losses in 2018, including auto, oil and gas, consumer durables, metals, capital goods and realty.
Plenty of head-winds
There are a few high-growth pockets in Indian markets. But with investors flocking to these select counters, their valuation has become too pricey.
However, lack of demand and regulatory concerns continue to plague sectors such as real estate, power, capital goods and infrastructure. Banks being over-laden with non-performing assets, credit growth is yet to turn robust. It’s mainly government spending that is powering the economy.
With the Lok Sabha election around the corner, the Centre may turn more populist, adversely affecting the economy. The RBI has also begun increasing rates, thus pushing up finance costs and hurting demand. A hike in commodity prices, especially crude oil, is expected to hurt corporate profitability further in the coming quarters.
Against this backdrop, it makes more sense for the stock market to pause and consolidate rather than tear higher in a mindless manner.