Not irrational yet

With the BSE Sensex toppling its lifetime highs on quite a few occasions lately, the mood in the markets wasn’t all that celebratory as the bellwether breached the 32,000 mark last week. In fact, the milestone saw several analysts sounding a cautionary note. In recent months, even optimistic market players have been toning down their bullish commentary on signs that the stock market is powering ahead purely on a tidal wave of liquidity, without the catch-up in corporate fundamentals really materialising. Though the Sensex has doubled in value between May 2012 and now, the earnings of Sensex companies have expanded at an anaemic 4 per cent annual rate. The repeated profit misses have stretched the price-earnings multiple of the Sensex from a moderate 16 times (trailing earnings) five years ago, to over 23 times now. Even as its current-year projections have repeatedly backfired, Dalal Street has been forced to peg up its forward estimates, to justify rising market valuations. At present the consensus expectation is for Sensex profits to deliver growth of over 20 per cent in FY18. But there is widespread scepticism about whether this is an attainable target.

Yes, such scepticism among seasoned market participants is a healthy sign, as it shows that irrational exuberance hasn’t yet taken hold. And given consecutive years of exceptionally low profit growth from India Inc, it may only be a matter of time before corporate profits revert to mean. But then, while seasoned market players may be aware of these ground realities and may accordingly position their portfolios, it is doubtful if this message will get across to domestic retail investors who have developed a new-found affinity for equities. One of the key factors that has distinguished this bull market from previous ones is the significant domestic liquidity flows that have propped up markets. With retail investors making a significant re-allocation in their favour, equity mutual funds have received over ₹80,000 crore in net inflows for each of the last three fiscal years. With the National Pension System and EPFO steadily increasing their equity weights, the pension savings of retail investors have a rising equity component as well. These are no doubt structurally positive developments, as they reduce the Indian market’s over-reliance on fickle FPI flows.

However, for retail investors to sustain their romance with equities, it is essential that they enjoy a good return experience from this bull run. Given the extremely low equity penetration in India, every bull market inevitably draws in first-time investors who erroneously chase past returns. This makes it important for money managers such as mutual funds, insurance companies and pension funds to ensure these investors stay away from excessive risk-taking. Barring their gates to new money or tempering return expectations will certainly mean lost business opportunities in the short term, but can lead to durable credibility gains in the long run. It is also in times such as these that mis-selling of equity products peaks, calling for greater vigilance by SEBI. It would also not be amiss for the regulator to caution investors by talking down the market from time to time.

COMMENT NOW