One-way street! As Nifty defies gravity, equity investors risk turbulence

With Nifty trading at a 17.7% premium to its average (CLSA calculations), nearly 2/3rd of Nifty stocks are now being sold at a premium to their average valuation.

Nifty’s 12-month forward PE is now being estimated at 18.6x. Only about 17% of the trading days since 2005, the index has been more expensive than the current PE, according to CLSA.

Indian equity valuations versus bonds are also inching toward the danger zone. The bond yield minus earnings yield is at 1.8 ppts, nearing the danger zone of 2 ppts. Most of Nifty’s tops have been at the 2 ppts bond yield-equity yield level, said CLSA’s Vikash Jain.

While the headline valuation may not look very expensive, it could be misleading due to the large contribution of banks to overall profits of Nifty. A sectoral break-up of net profits of Nifty50 index across shows that the contribution of banks has gone up from 21% in 2022 to 27% in 2023.

“We focus on bottom-up valuations but find valuations very expensive in most cases in the context of past valuations that were supported by low global interest rates and future disruption that is not factored in valuations clearly,” said Sanjeev Prasad of Kotak Institutional Equities.

Analysts also do not find any particular reason for the excitement in mid and smallcaps which has outpaced Nifty by a wide margin in the last 2-3 months.Top value investor Vijay Kedia has also warned investors by asking them to not always trust what they hear or see. “In the bull market even a ‘no brainer idea’ could be a ‘brainless idea’,” he said.

Kotak’s team admitted that they are struggling to find ideas in the consumption, investment and outsourcing sectors after the sharp run-up in several of their favored sectors and stocks in the past two months.

“Most stocks in these sectors are trading at close to or above our 12-month fair values. Valuations of outsourcing sectors may look reasonable versus history but the IT services sector faces both short- and medium-term challenges. Valuations of most BFSI stocks are still attractive despite the recent run-up in insurance stocks,” Prasad said

Earnings fear
Kotak expects net profits of Nifty to grow 15% in FY2024 and 14% in FY2025.

Dalal Street veteran Dhananjay Sinha has warned that earnings projections for FY24 can undergo sharper correction of about 15% compared to the 4% correction in FY23.

“The ongoing slowdown in private demand would imply downward reset in expectations across most sectors. Amongst these Banks, NBFCs, Autos, Cement and Logistics appear to be most optimistic. Sectors exposed to lower risks to downgrade are Consumers, IT, Insurance and Utilities,” said Sinha of Systematix Institutional Research.

He sees lower valuation risks for Infra, Oil & gas, Utilities, Pharma and IT. Moderate to high risks would be in cap goods, FMCG, auto, Metals and Cement. The high-risk sectors would be Banks, Realty and Midcaps, he said.

FII concern
The single biggest trigger for the market rally since the lows seen in March 2023 is being attributed to FIIs who have poured in around $15 billion so far in FY24 on expectations of likely peaking of global interest rates and on improving macro-outlook in India.

However, the strong and broad-based market rally has tempted strategic investors, especially PE/VC funds, to accelerate their exits to a higher level versus previous quarter.

The risk to FII flows in the rest of FY24 could come from earnings downgrades that could move up India’s valuations even further. “Our global composite ranking puts the Indian benchmarks at high levels (Nifty at 6 and Sensex at 9 out of 25 global indices) despite rich relative valuation (24th in valuation ranking). This is because high valuations are counterbalanced by hugely optimistic earnings projections (16% for FY24E vs 11% in FY23 and 14% for FY25E),” Sinha said.

(Disclaimer: Recommendations, suggestions, views and opinions given by the experts are their own. These do not represent the views of The Economic Times)