Where is the market headed?

Where is the market headed?

The million dollar question that springsin everyone’s mind is “Where is the market headed” and whether valuations are stretched?” and will there be a correction and to “what extent the markets may correct”.Investors will do well to remember that there are two ways in which a market can correct. One is time bound correction and the other is value based correction. In a time bound correction phase the markets remain flat for some time and trade sideways before they start their upmove. In a value based correction stock prices correct and provide investors to buy stocks at reasonable valuations.

The benchmark Indian stock indices are hovering around 52-week highs on the back of strong FII inflows for the past few months. But, sustenance of the current momentum will depend on pick-up in corporate earnings growth, CPI trajectory, reforms momentum, liquidity (global & domestic) and international macro-economic events.

One area of concern though is the slowdown in GDP growth in Q1FY2017. Figures released by the Statistics Office show GDP growing by 7.1% in Q1FY2017, the weakest in five quarters and down from 7.9% in the preceding quarter. The print was well below the 7.6% growth forecast by economists. Growth was dragged down by a contraction in mining and a sluggish agriculture sector.

Meanwhile, GST appears to be a done deal at the moment with 17 states so far ratifying the Constitutional Amendment Bill. The government needs go-ahead from 16 states to turn the Bill into a law. The timing of the GST rollout is still uncertain though, as the crucial issue of the GST Rate is still being debated among various stakeholders. The government has planned to roll out GST regime from April 1.

Globally, weak demand, low bond yields and easy liquidity are quite supportive for equity in general and emerging markets (EM) in particular. Bond yields in the developed markets (DM) are close to historic low levels and central banks too are willing to maintain the loose monetary policy, resulting in ample liquidity. Risk aversion is at an all-time low, indicated by the CBOE VIX (Chicago Board Options Exchange Volatility Index; a popular and widely used indicator to gauge of market sentiment) falling to multi-year low. Although an interest rate hike by the Federal Reserve is a potential disruptive risk, but the weak US jobs data has reduced the probability of a rate hike in the immediate future.

Q1FY2017 results were largely in line with expectations. In the past two years, the earnings growth has fallen short of expectations at the beginning of a financial year. Consequently, the Sensex earnings estimates have been downgraded by 20-22% for FY2017 and FY2018 in the past 12-15 months. However, the intensity of downgrades has subsided in the past few months and consensus earnings estimates have also remained quite stable.

Indian markets have rallied significantly since the beginning of the financial year, and therefore valuations are not cheap anymore. On PE (price/earnings) basis, the Sensex trades at ~17x one-year forward earnings estimate, which is at a premium to the long-term average PE multiples. However, on a macro-centric metric (ie Market Cap-to-GDP), the Sensex trades at a comfortable level of 0.8-0.85x GDP. However, a strong revival of growth in the corporate earnings will be a key driver for further re-rating of the Indian markets.If the corporate earnings fail to materialize then Indian stock markets are likely to witness some correction.

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Our Take: The nifty at the current value of 8769 trades at about 23.9x its FY16 EPS. History has shown that whenever nifty crosses 22x its trailing twelve month EPS it is better to be cautious as the peak valuation was around 28x its twelve month trailing EPS in 2000.However investors should not be too pessimistic about the markets as global growth engine has slowed and India being one of the fastest growing economy is bound to see sharp pull backs when there is a correction. Investors must be ready to latch on to some good stocks when there is a correction and must have 30% of their portfolio’s in cash that will help them to go for bottom fishing and make substantial gains. Always remain 70% invested while maintaining 30% cash which will help you to cushion any fall in stock markets beyond anticipated levels. While we don’t foresee a correction beyond 10-15% in the near term global risks and rising geopolitical tensions with Pakistan continue to pose risk to the markets. So it is better to always remain on guard and save our hard earned money. Investors must not remember the two golden rules of Warren Buffet i.e Rule 1: Don’t loose money and Rule 2: Don’t forget rule1.

Happy Investing!

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