Sensex hits nearly two-year highs on strong global cues
A surge of liquidity pushed Indian benchmark indices to nearly a two-year high before investors took some money off the table. While these gains are in line with the return of risk appetite in global equities, high valuations and continued earnings downgrades call into question the sustainability of this rally, experts said.
On Thursday, the 50-stock Nifty tested a 23-month high intra-day level of 8970, before closing at 8,939.50, just 0.14% higher than the previous day. The 30-stock Sensex touched 29,000 during the day before closing at 28,892.97, up 0.1%.
“Only liquidity is driving the market and there is no fundamental support,” said Ambareesh Baliga, an independent equity analyst.
Since the start of this year foreign portfolio investors have bought Indian stocks worth $1.3 billion after selling $4.6 billion in the December quarter. Consequently, Indian equities have rallied 9% so far this year in line with other global indices. The MSCI Emerging Market Index, in comparison, is up 8.8% since the beginning of this year.
However, with no earnings support, valuations are also starting to look expensive, said analysts. The Sensex is currently trading at 20 times its estimated earnings for the next year compared to a 10-year average of 16.31.
Returns will be capped owing to “posible near term reversal of global wave, market’s under-appreciation of residual impact of demonetisation , rich valuations and continued risks of earnings downgrades,” wrote Bank of America Merrill Lynch analysts in a note to clients on Thursday. The brokerage has a 29,000 target for the Sensex in December, little higher than Thursday’s close.
WITH NO EARNINGS SUPPORT, VALUATIONS ARE ALSO STARTING TO LOOK EXPENSIVE. THE SENSEX IS TRADING AT 20 TIMES ITS ESTIMATED EARNINGS FOR THE NEXT YEAR, AGAINST A 10YR AVERAGE OF 16.31
With December quarter financial results season ending, analysts have slashed earnings forecast not only for the current fiscal, but also for the next year. Indeed, data from Bloomberg shows that the consensus Sensex earnings per share forecast among the analysts it polls has come down by 1.5% for the current fiscal and 2.4% for the next.
Analysts are cautious that effects of demonetisation will be prolonged and rising commodity prices and the implementation of the goods and services tax (GST) later this year will hurt earnings growth. “Slowdown in consumption and commodity cycle pricing are key concerns,” said Yogesh Mehta, a vice-president at brokerage Motilal Oswal Financial Services Ltd.
Even a slightly more optimistic brokerage like Kotak Institutional Equities, has said that earnings recovery will be largely due to sector-specific factors and not “fantastic hopes of a domestic economic recovery.”
In a February 16 note, Kotak analysts warned that there are “downside risks to earnings in cement, consumer discretionary and industrials if domestic demand conditions were to stay subdued.”
To be sure, there is no shortage of believers too.
“Returns in other assets like gold, fixed income and real estate are not giving good returns. From this perspective, it looks like investors’ continuous fund allocation to equities will drive the rally,” said Pankaj Pandey, head of research at ICICI Securities Ltd.