THE PANDEMIC-INDUCED fear that gripped the world in March 2020 had a profound impact on the stock markets, pushing them into a state of excessive fear, which, in hindsight, laid the foundation for the subsequent bull run. Since then, Sensex has zoomed over 41,045 points from its March 2020 low of 25,639, and Nifty has moved up 12,334 points from 7,511.
Thanks to massive balance sheet expansion by the U.S. Federal Reserve and the European Central Bank (ECB) during the pandemic, the world is awash with liquidity. Despite recent hikes in interest rates, money is pouring into Indian equities in search of higher return.
Interestingly, in 2022, India, the fifth-largest stock market (Nifty) posted a gain of 4.3%, while the top four, including the U.S. (S&P 500), China (CSI 300), Germany (DAX), and Japan (Nikkei 225) posted negative returns of 18%, 21%, 12.35%, and 9.37%, respectively. In the last one year, between July 21, 2022 and July 21, 2023, the Nifty has returned around 19%, almost three times more than what bank FDs offer on an annual basis.
Follow the Growth
So, what’s behind the resilience of the Indian stock market?
While the developed world is parched with recession, India offers an oasis of growth where real GDP is still expanding at 6.5-7.5%. On the back of stable economic growth, the Nifty 500 companies that represent 92% of India’s total market capitalisation posted an all-time high profit of ₹11.1 lakh crore in FY23.
Between June 2020 and June 2023, overseas funds, including global funds, emerging markets funds and Asia plus Asia-Pacific funds had increased exposure to Indian equities, according to Morningstar. Global funds’ exposure to India moved up from 1.11% to 1.3%, while emerging market funds had taken a huge bet on India by increasing exposure from 9.04% to 15.11%. Asia and Asia-Pacific funds’ exposure in the Indian market rose from 10.43% to 16.3% during the same period.
In absolute terms, the value of India allocation by overseas funds has gone up from $158.8 billion in June 2020 to $281.2 billion in June 2023. Currently, global funds, emerging market funds and Asia plus Asia-Pacific funds own $97.6 billion, $152.8 billion and $30.9 billion, respectively.
Indian markets are seeing record flows from foreign institutions. According to the Central Depository Services Ltd. (CSDL), foreign portfolio investors (FPIs) have poured a record ₹1.2 lakh crore in this calendar year. Higher inflows coupled with a rising stock market increased India’s share in the global market cap to 3.3%, against the long-term average (10 years) of 2.6%.
Currently, the Indian equity market is in a rare phase where valuation metrics are highly expensive relative to its long-term average. But still, market participants prefer equities over other asset classes. On price to book (P/B), price to earning (P/E) and market cap to GDP metrics, the Indian equity market fetches a valuation way above its long-term average. So what has changed in recent times and why is there a high divergence from historical average?
Behind the Nifty Premium
Going by traditional financial metrics, the Indian market looks expensive as the MSCI India index is trading at 112% premium to the MSCI Emerging Markets (EM) index on earnings multiple basis. MSCI India is trading at 27 times against MSCI EM’s multiple of 12.7. Long-term average of MSCI India premium over MSCI EM is 71%.
With 113 constituents, the MSCI India index covers around 85% of the Indian equity universe. Currently, China, Taiwan and India are the top three countries in the MSCI Emerging Market Index with a weight of 32.11%, 15.26% and 13.23%, respectively.
According to brokerage house Motilal Oswal, Nifty is trading at 3.1 times on a 12-month forward price to book (P/B) basis, a 14.8% premium to its 10-year historical average of 2.7 times. And India’s market cap to GDP ratio at 104% is way above the long-term average of 81%.
Why do Indian equities command such a high premium? One reason is strong corporate earnings that are not volatile in nature. Another is moderate inflation of 5-6% in a world where developed nations are struggling to control rising prices.
For starters, it is important to understand the two factors that majorly decide the direction of equity markets — price of money, which is interest rate, and the expectation of corporate earnings growth. For a stock market to move up, interest rates must fall, and corporate profit must rise. The corporate profit for the Nifty 500 universe recorded 49% YoY growth in FY22 and 50% in FY21, while in FY23 profit went up 8.8% on a higher base.
For FY24, consensus Street estimate for earnings per share (EPS) of Nifty 50 companies is ₹964, or 19.6% above last fiscal’s EPS of ₹806.
Market participants believe re-rating of sectors, especially banking, and corporate deleveraging on the back of strong earnings growth are fuelling the upward movement of the index. The biggest overhang on corporate balance sheet was debt and for a change, instead of amassing debt, corporate India is repaying loans.
The banking and financial sector carries the largest weight in Nifty (37.92%). The outlook for Nifty earnings has improved primarily due to improvement in financial sector earnings. Gradually, financial companies are getting re-rated by the Street.
For the record, in FY20, banks clocked a net profit of ₹1.02 lakh crore. In just three years, banking companies’ profits increased 135% to ₹2.4 lakh crore. In FY23, PSU banks made a profit of ₹1.1 lakh crore while private banks registered ₹1.3 lakh crore profit. Reduced provisioning for bad loans is strengthening the bottomline of Indian banks.
This optimism is well captured in the share price of State Bank of India, India’s largest bank, which gave a handsome return of 216% during the period.
Impact on Indian Investors
The fear of missing out (FOMO) mindset and there is no alternative (TINA) to equities fever is gripping retail investors as well. To add fuel to the fire, the stock market has caught the fancy of retail investors who have been starved of safer investment options due to low interest rates on savings. Since 2019, demat accounts have almost tripled from 4 crore to 11.4 crore.
Indian retail participation through mutual funds is also making new records. In the current fiscal, retail customers have poured around ₹14,000 crore every month into equities through systematic investment plans (SIPs). For FY23, total gross SIP flows stood at ₹1.56 lakh crore, or ₹13,000 crore per month.
The soaring index has emboldened retail customers, who are now directly dabbling into equities. The massive bull run since the pandemic has created a trading frenzy and it is evident from trading volume in the futures and options (F&O) segment, which is crossing ₹100 lakh crore on weekly and monthly expiry days. BSE listed companies’ market cap stood at ₹303 lakh crore on July 21. It implies that in a single day, about 33% of total stock market capitalisation is just getting traded in the F&O segment, which is unprecedented.
If one analyses the historical bubbles of stock markets, one thing will stand out starkly — the crest of market euphoria has always corresponded with trough of rationality among participants. The retail trading frenzy that has gripped the market is indicative of investor optimism. However, retail investors should always exercise cautious optimism and not treat the stock market as a casino.