Unwinding seen in overheated stocks

India’s red-hot stock markets are ripe for a round of consolidation as investors look to lock in profits with the expiry of monthly contracts due in the coming week. Shaky global sentiment, especially uncertainty over deepening probes into US President Donald Trump’s links to Russian officials, should also weigh.

The top-30 Sensex breached all-time peaks on Friday for the fourth time in five sessions, but pulled back towards the close as caution took over. A correction in prices would be healthy for the market that has been on a bull run for much of this year. There are many positive developments that hold out hope for the long haul.

“The market has been on a roll,” said equity strategist Milind Desai. “It needs to cool down a bit. The expiry could be the trigger.”

Monthly options and futures contracts are settled on the last Thursday of every month, and trading around this time tends to become volatile. With benchmark indices climbing to a series of record highs, the Indian market trades at a 40 per cent premium to the MSCI Emerging Market Index, compared with 30 per cent premium usually, making Indian stocks among the world’s most expensive.

“The market move over the last few weeks has been like a fairy tale,” Gautam Shah, senior vice president and technical analyst at JM Financial, told BloombergQuint. “The market is looking slightly overbought on the short-term technical charts having run up this far, so soon. This does call for some consolidation.”

He expects the Nifty to breakthrough 9,500 forcefully again after a correction, and then head to 9,750.

One key factor behind the stocks surge has been the dominance of domestic funds whose kitty has been swelling thanks to falling interest rates and a marked preference for equity among savers. Foreign funds, usually the lead players, have been playing second fiddle. With the market climbing to record highs almost every day, many investors who missed out are waiting to jump in when a correction happens.

A run up in price-earnings (PE) multiple must be seen in the context of stronger expected earnings, and the drop in riskfree yields, according to Prateek Agrawal, chief investment officer at ASK Investment Managers.

“While markets may be higher in terms of average PE, we believe they would sustain their levels and retain an upward bias,” he told the Economic Times. “Drop in risk-free yields lowers the discount rate used for computing the present value of future cash flows. This increases the value of the same. A 10 per cent drop in yields makes sustainable PEs to be over 10 per cent higher.”

So, if 16.5 times is the 10-year average one-year forward PE, the drop in yield would mean that 18.5 times is the new normal, he said.

Overall earnings growth in 2017-18 may turn out to be better than expected helped by “tailwinds from deferred demand from the demonetisation period”, benefit of inventory buildup post GST and the statistical low base in the previous year. Already quick indicators are showing robust strength — cement demand and prices are up and auto sales are picking up.

GST set to roll

The Sensex hit a peak of 30,712.35, up 15.3 per cent since the close of 2016, before pedalling back to 30,464.92 at close, still up 0.9 per cent on the week. The 50-share Nifty rose to a record 9,532.60 on Wednesday and ended at 9,427.90, gaining 0.3 per cent over the week.

Bullish undertone

The confidence in the medium to longer term outlook comes from improving economic growth, higher consumer spends, benign inflation expectations, good monsoon forecast and a new Goods and Services Tax (GST) that is set to roll out from July 1.

After much debates and dilly-dallying a consensus has been reached to have four slabs of taxes for goods and services — 5, 12, 18 and 28 per cent. Most food items that have a combined weighting of nearly 50 per cent in the consumer price index have been exempted from any levy, ensuring the GST does not pinch the common man’s pocket.

Shares in many mid- and small-cap companies have brought windfall gains to smart investors over the past one year. One such stock is Indiabulls Ventures Ltd, a brokerage in equity, commodity and currency markets as well as engaged in marketing and distribution of residential properties and developing and leasing of commercial properties.

Formerly known as Indiabulls Securities Ltd, the shares closed at Rs131.50 on Friday after hitting a high of Rs152 this week — soaring more than seven times in less than five months from Rs20.50 at the close of 2016.

Shares in C & C Constructions Ltd, which specialises in turnkey projects for National Highways Authority of India, Railways, CPWD, Punjab Infrastructure Development Board and public works department of various state governments to name a few, have shot up by nine times — from a measly Rs8.15 a year ago to Rs72.90 earlier this month. The stock closed at Rs62 on Friday.

Shares in Goldstone Infratech Ltd, the leading maker of composite insulators in India, have leapt more than six times in 11 months. The stock closed at Rs94 after touching Rs107.60 in April, compared with Rs17.10 a year ago.

Some of the stocks where mutual funds have made big investments in recent months are Federal Bank, Max Financial Services, Tata Chemicals, Dalmia Bharat, Muthoot Finance, City Union Bank, Canara Bank, Allcargo Logistics, Raymond and Tube Investments.