Rational or irrational exuberance?

THOUGH a broad-based pick up in economic activity is unlikely in the near-term, the Indian stock markets have surged ahead, shrugging off growth concerns.

As Chart 1 shows, the Sensex has surpassed its previous highs, gaining roughly 30 per cent since May 2014, when the NDA government was formed. While market participants are concerned about current valuations, it is difficult to say for sure whether markets are overvalued or not.

As Chart 2 shows, the Sensex currently trades at a PE ratio of 23.7, which is above its historical average, but remains below the highs of 2007-08. Similarly, in the market capitalisation to GDP metric too, the current valuation is lower than the highs of 2007-08 (Chart 3). Notwithstanding concerns over valuation, both FIIs and DIIs have continued to pour in money (Chart 4), though the former have withdrawn some funds of late. The data show domestic flows and retail flows in particular, have surged of late, especially after demonetisation. Net inflows into equity mutual funds rose to ~67,070 crore in the period from November 2016 to June 2017, up from ~23,570 crore over the same period last year (Chart 5).

Retail participation also has increased sharply, with investments through SIPs averaging around ~4,300 crore a month, up from ~3,430 crore, prior to demonetisation (Chart 6). As a consequence, assets under management of equity mutual funds rose sharply, touching ~5.34 lakh crore at the end of June 2017, up from ~2.3 lakh crore in June 2014 (Chart 7).

But, the worry is whether earnings, expected to grow at 13.7 per cent this year (Chart 8), will catch up or not. The key economic data, to be released later this week, are being keenly awaited for deciphering the state of the economy.