Resistance mounts in record-high shares despite strong earnings
ropelled by expectations for accelerated growth rates Indian stocks have been riding a wave of exuberance, causing bloated valuations and making the most expensive market in emerging Asia vulnerable to a sharp fall when cash flows change direction.
Signs of investor fatigue was evident even as benchmark indices climbed to record highs last week, and the consensus among pundits is for prices to retreat over the coming weeks rather than climb higher. The top-30 Sensex and the 50-share Nifty closed at 29,858.8 and 9,285.30 respectively, both notching modest weekly losses for the third time in the past four weeks.
“The answer to market being in a prolonged overvalued zone probably lies in three distinct factors,” wrote Dhananjay Sinha, head of research and strategist at securities house Emkay Global.
“One, central banks, led by the US Fed, have been pumping up asset prices by actively depressing risk-free rates and market volatility to compensate for lack of earnings growth. The collateral surge in flows into emerging markets, including India, also resulted in asset price misalignment with fundamentals.”
Corporate earnings were better than expected in many instances, but the rally in stock prices was much more. Another problem is the sort of funds that have flowed into the market. The lion’s share of foreign cash inflows has been to exchange-traded funds, or ETFs, which are hot money liable to move out at the first sign of trouble.
The share of ETFs in the total foreign institutional inflows is about 45-50 per cent so far in 2017, according to BNP Paribas, off 60 per cent in 2016 but sharply above 16 per cent in 2014.
“Flows into ETFs are often driven by the performance of the market and, since most ETFs are based on frontline indices, ETF flows influence share price movement of large cap stocks more than those of small and mid-cap ones,” Manishi Raychaudhuri, BNP’s Asia equity strategist, said in a note.
Ideally, stocks rally must be supported by stronger earnings and the potential for sustained growth. While consensus opinion is for faster rise in profits, there are hiccups along the way. A new Goods and Services Tax, scheduled to roll out from July, should provide a thrust to manufacturing and services in the longer run, but there could be disruptions during the changeover and initial period.
Stock valuations in some sectors are especially high. The MSCI India telecoms sector, for example, is trading at a forward price-earnings multiple of 62, nearly triple its five-year average of 22.
“This precarious balance between valuations, earnings growth and riskfree rate is critical for financial markets,” Sinha wrote. “The point is that all these variables are displaying crucial attributes — risk-free rate at historical lows, multiples at historical highs and earnings stagnant.”
Foreign interest
The silver lining for India is the growing foreign direct investment, a steady form of cash inflows, happening in a wide range of sectors.
Dubai-based DP World, which has invested $1.2 billion (Dh4.4 billion) in India and operates a string of ports, including a major one in Mumbai, last week pledged to pump another $1 billion into developing logistics over the next two years.
“We are very excited about the opportunities in India. We are not constrained for capital given the right commercial and economic dynamics,” Chairman and CEO Sultan Ahmad Bin Sulayem said in New Delhi.
Among the proposals on hand are warehouses, cold storages, online transactions, customs services, inland waterways and so on.
The potential is huge given that China, with a comparable population, handles 100 million containers while India barely reaches 10 million.
According to road transport and highways minister Nitin Gadkari, foreign investors including Singapore-based DBS are keen to buy and operate governmentowned national highways projects.
“The DBS CEO met me last week in Singapore and expressed the group’s willingness to invest almost $7 billion in buying into existing highway projects under the “toll operate transfer’ policy,” he told the Economic Times newspaper.
Construction and engineering firm Punj Lloyd and Israel Weapon Industries have launched a joint venture to make small arms for the defence forces.
India has opened up the sector, long a public sector monopoly, to private participation.
MSCI rejig
Morgan Stanley Composite Index, a benchmark that plays a major role in determining foreign fund allocations, is due for a rejig on May 16 and there is talk that four Indian companies would find a place in the coveted marker.
State-controlled Indian Oil Corp, the country’s biggest oil marketing company, private-sector Federal Bank, Rural Electrification Corp and Petronet LNG are tipped to be included in the MSCI emerging market index. The weights of ICICI Bank, the leading private sector lender, and Grasim Industries are likely to be raised.
As inclusion in the index would lead to greater foreign flows into these stocks, bidding for them have already started and should sustain when the change becomes effective June 1.
Brokerage CLSA is upbeat on housing finance companies as the government’s ambitious target of ensuring a home for every family gets going.
The sector should see 8 per cent compounded annual growth rate in volume and 13 per cent in the value of housing finance sales over financial years 2017-24, it said in a note.
CLSA is bullish on HDFC Ltd, LIC Housing Finance Ltd and Indiabulls Housing Finance Ltd.