Updated on 7 Aug 2017
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Stocks at peak? Not all valuation parameters suggest so
Dalal Street is now busy drawing parallels between the Nifty's 2007-08 peak and its recent climbs past the 10,000 barrier. The all-time record highs have meant 23% YTD gains -and 74% in the past four years. The sharp rally in the broadest gauge for Indian equities has, understandably, put the microscope on valuations and the likelihood of a correction.
The following valuation parameters indicates that equities are far from peaking except PE ratio.
CONVENTIONAL VALUATION MULTIPLES
It is true that at 23.3, the Nifty's PE multiple might be close to that in January 2008, when the previous bear market set in. But on most other valuation parameters, equities appear way cheaper.
For instance, on the price-to-book multiples, the Nifty is at 3.6 times currently, against the peak of 6.6 times in early 2008. India Inc's market capitalisation-to-GDP is at 90% currently in comparison to 150% during the January 2008 peak. With earnings growth set to revive soon, the price-to-book and m-cap-to-GDP are better valuation yardsticks than simply the PE.
The earnings-to-GDP ratio is the lowest in the last 10 years -at 3% now, compared with 7.1% in FY08.This shows that corporate earnings are at cyclically low levels and analysts expect them to rise from the second half of the year.
RATE CYCLE, 10 YEAR G-SEC YIELDS AND CAPEX CYCLE
Data since 2000 show a degree of correlation between rates and equity indices -albeit with some lag effect. Directional changes in the rate cycle clearly mark the beginning of either economic contrac tion or expansion.
During the previous rally, G-sec Yields rose from 5.1% in 2004 -the beginning of the rally -and peaked at over 9% in 2008. At present, the rate cycle is trending down and the economy is expected to pick up once a softer rate regime kicks in. This also indi cates that the Capex cycle was at its peak in 2008, while it is bottoming out now and yet to revive.
In 2007, the commodity cycle was at its peak and witnessed a major crash in 2008. The Bloomberg commodity index nearly tripled from 2001 to 2008, to 240 levels. The index is at 84 now, near the lower levels of the past 20 years. Lower commodity prices, particularly of steel and coal, should aid Capex decision making.
The previous rally was dominated by overseas cash, which enters and exits quickly and can be short-term in nature. By contrast, the recent rally is expected to last longer as it is locally driven, and any significant dip is likely to be bought into. The Nifty, for instance, has not corrected more than 5% in the last 231 trading sessions. In 2007, DII flows were around 30% of the FII flows, while the equations has reversed now. FIIs flows in the current year to date are 40% of the DII flows.
So as long as DII (Domestic Intuitional Investors) are buying then it is very hard for markets to have sharp correction. Some technical correction is possible but major corrections are very rare.