Helping You Build Wealth With Honest Research
Since 1996. Try Now

MEMBER'S LOGINX

     
Invalid Username / Password
   
     
   
     
 
Invalid Captcha
   
 
 
 
(Please do not use this option on a public machine)
 
     
 
 
 
  Sign Up | Forgot Password?  


Indian Indices at Record High; Metal Sector Up 4.9%
Tue, 23 Jan 11:30 am

Stock markets in India have continued their momentum and are presently trading on a positive note. All sectoral indices are trading on a positive note with stocks in the metal sector and energy sector witnessing maximum buying interest.

The BSE Sensex is trading up 222 points (up 0.6%) and the NSE Nifty is trading up 76 points (up 0.7%). The BSE Mid Cap index is trading up by 1.2%, while the BSE Small Cap index is trading up by 0.6%. The rupee is trading at 63.76 to the US dollar.

With Indian Indices trading at all-time high levels, the question many have in mind is if the Indian stock market is overvalued. To gauge this, we generally refer to PE or price to earnings ratio. If we go by this ratio, the Indian market is clearly in overvaluation territory. The Sensex is trading at a PE of around 26 times.

However, there is still another ratio, which is frequently used to evaluate the valuations. The market capitalization to GDP ratio. It is one of Buffett's favourite indicators of broader market value. The market cap of all the listed companies in the country divided by the gross domestic product (GDP) of the country gives us this ratio.

The idea behind this ratio is simple. Stock prices are derived from expected earnings for corporates and GDP represents revenue of the country. This gives investors an estimate of whether the two are moving in tandem. A ratio above 100% shows overvaluation and one below 50% shows that the market may be undervalued. So what does the ratio presently indicates about Indian stock markets?

The Warren Buffett Indicator Suggests Indian Equity Market Is Overvalued


As can be seen from the chart above, the Market cap to GDP ratio for Indian companies is close to dangerously high levels. While this is still some way off the peak of FY-08, when it had once reached close to 150, it's relatively high.

As we wrote in a recent edition of The 5 Minute WrapUp...

  • FY17 saw this ratio reach close to 80. It is also expected to increase further given the moderate growth expectations in India's GDP for FY18. Warren Buffett once considered this as one of the best valuation metrics to gauge the markets.

    Past history shows some correlation between the ratio and the share market. 2008 saw Sensex decline by 38%, when this ratio crossed the 100 mark. Also, the market has bounced back sharply when this ratio was low.

    The basic assumption in this ratio is that whenever the GDP of the country grows, the market performance will reflect it. Also, when stocks do well, it can be extrapolated to assume the Indian economy is doing well.

    The only caveat in this ratio is the number of households involved in the stock market. While in countries like US, 50% of the households are invested in the stock market, India stands at just 2-3%. As a result, when the economy grows, all of the money might not enter the stock market.

    But unless there is growth in earnings, it makes sense to tread with caution at current levels.

In all, 2018 will, therefore, be critical for Indian companies to justify their valuations with earnings growth. Investors must remain cognizant about valuations and ensure they take some profits off the table whenever the opportunity is ripe for the picking.

In the news from currency markets, the rupee edged up 5 paise to 63.82 against the US dollar today. This was seen on the back of increased selling of the dollar by exporters and banks.

Note that the rupee surged almost 6% against the dollar in 2017, mostly driven by strong inflows into capital markets.

The appreciation in the rupee comes as a welcome breather for importers in India. A softer rupee helps importers to buy goods and services at a cheaper rate that earlier. This is vital for a developing economy that relies heavily on imports. So this bodes well for the Indian economy as higher imports normally mean increased economic activity.

But on the other hand, the rise in rupee can spell trouble for exporters. The exporters are at a disadvantage owing to the currency appreciation as this renders their produce expensive in the international markets as compared to other competing nations whose currencies haven't appreciated on a similar scale. This tends to take away a part of the advantage from Indian companies, which they enjoy due to their cost competitiveness.

Nonetheless, a stronger rupee will pull down commodity prices and help in keeping a tab on rising inflation.

While there are advantages as well as disadvantages of a rising rupee, one needs to understand whether the rise in the rupee is sustainable to derive any reasonable conclusion at this stage.

For one, the weakness of the US dollar is largely due to the relative unattractiveness of US assets. This is in part due to a very low interest rate regime prevalent in the US economy. Already there are indications that this low interest rate regime may not be sustainable for long. This means that US interest rates may go up and this may likely strengthen the US dollar.

It would be interesting to see how the above trend pans out in 2018. We'll keep you updated on the developments.

For information on how to pick stocks that have the potential to deliver big returns, download our special report now!

Read the latest Market Commentary


Equitymaster requests your view! Post a comment on "Indian Indices at Record High; Metal Sector Up 4.9%". Click here!