Will the boom trend in the equity markets continue?

Indian markets (along with a number of global peers) are experiencing a boom, not seen too often in the past. Apart from the frontline benchmark indices, the sharply rising broad retail participation is testimony to the celebrated gain in the markets. The overall active client base for the broking industry increased by ~85% YoY to 23.8mn in July 2021. More than half of current active accounts in the country have been opened in the on-going bull run since March 2020 – with most of them being first time investors and hence having no experience of seeing a meaningful correction. From 4% market share in FY14, the share of discount brokers has risen to close to 50%. One of the large discount brokers recently said that nearly 80% of their new clients are under 30 years and nearly 90% of them are from small towns.The markets continue to be strong. Nifty 50 Index is up 2.3x since March 2020 lows whereas Mid/Small Cap Indices are up 2.7x/3.1x. Nearly 10% of Nifty500 Index constituents were up over 5x during this period.High frequency data indicate continuous economic recovery. Fertilizer sales increased MoM from 6.6MT to 8MT. India exported the highest ever merchandise exports of USD35.2b in Jul’21. Railway freight increased 18% YoY; the Services PMI increased to 56.7 – best since Feb’20. Government gross receipts as % of Budgeted Estimates (BE) stood at 11-year high of 27.7%. Fiscal deficit for the first four months was just 21.3% of BE – one of the lowest numbers in over 2 decades. Daily e-way bill generation increased 13% MoM in Jul’21. The Indian economy expanded at a record 20.1% yoy in 1QFY22, but 2-yr annualized growth was -4.7% (decline).Corporate earnings growth is continuing its strong show with consensus estimates pegging current financial year’s earnings growth at over 25% yoy. The corporate earnings to GDP ratio rose to 10-year high of 2.6% in FY21.It is well understood that India has some of the most favourable demographic trends in the world. India is now positioned to attract capital for investment that can aid productivity growth for the Economy. India is well positioned with an unlevered corporate, and household sector, improving RoIC supporting corporate sector valuation, and a balanced Current Account, that is turning structurally positive. The turbulence in China has been accompanied by resilience in EM ex-China trends. This trend is poised currently at a good launchpad for a durable takeoff. While India has 11.6% weight in the MSCI EM Index, the weight goes up to 17.4% for the ex-China version. This can be a catalyst for India flows.Over 50% of the Indian adult population has got at least one dose. Active cases are down 89% since the second wave peak is early May 2021, but have been inching up over the last fortnight.While longer term movements are guided by corporate earnings and economic growth, near term can get influenced by a host of variables – one of the major ones being liquidity. While we all are aware that the markets are impacted by liquidity, there is no objective number to it, nor is it listed somewhere. Money supply can be a good proxy for liquidity. We took the money supply of the top 13 countries / regions of the world and added them together to give us a close proxy of global market liquidity. A look at the chart below confirms the high degree of correlation between equity market movements in near term with liquidity (Global liquidity in blue, MSCI World Index in green).With key central bankers of the world continuing with their asset purchase programs, the liquidity continues to remain strong, at least in the near term. In a record low rate and high liquidity environment, economic recovery along with revival of corporate earnings growth bodes well for equity as an asset class. The global pile of negative-yielding debt has grown to more than $16tn. There is reasonable consensus that rates are at significant lows with virtually no room for further cuts. The Fed is expected to start tapering the asset buying program from the end of the year. This could put pressure on global equity valuations.Wholesale Inflation in India has been in double digits for the last 5 months – for the first time in 13 years. The gap between India 10-year yields and Repo is close to 10-year high – indicating that the market is not expecting a rate cut at least. RBI has maintained the accommodative stance, prioritizing growth.Even if rate hike cycle were to begin, it is interesting to note that Nifty delivered strong earnings growth trends during the past Fed hike cycles & market returns tended to track earnings growth. Continued growth momentum in initial stages of hiking could more than offset rate increases. The taper tantrum happened post May’13 comments from then-Fed Chair Bernanke while the tapering started in Dec ’13. INR sharply depreciated and the Indian market sold off ~12% over the subsequent 4 months.As per Bloomberg data, based on consensus estimates, Nifty is trading at one-year forward P/E

Will the boom trend in the equity markets continue?
Indian markets (along with a number of global peers) are experiencing a boom, not seen too often in the past. Apart from the frontline benchmark indices, the sharply rising broad retail participation is testimony to the celebrated gain in the markets. The overall active client base for the broking industry increased by ~85% YoY to 23.8mn in July 2021. More than half of current active accounts in the country have been opened in the on-going bull run since March 2020 – with most of them being first time investors and hence having no experience of seeing a meaningful correction. From 4% market share in FY14, the share of discount brokers has risen to close to 50%. One of the large discount brokers recently said that nearly 80% of their new clients are under 30 years and nearly 90% of them are from small towns.The markets continue to be strong. Nifty 50 Index is up 2.3x since March 2020 lows whereas Mid/Small Cap Indices are up 2.7x/3.1x. Nearly 10% of Nifty500 Index constituents were up over 5x during this period.High frequency data indicate continuous economic recovery. Fertilizer sales increased MoM from 6.6MT to 8MT. India exported the highest ever merchandise exports of USD35.2b in Jul’21. Railway freight increased 18% YoY; the Services PMI increased to 56.7 – best since Feb’20. Government gross receipts as % of Budgeted Estimates (BE) stood at 11-year high of 27.7%. Fiscal deficit for the first four months was just 21.3% of BE – one of the lowest numbers in over 2 decades. Daily e-way bill generation increased 13% MoM in Jul’21. The Indian economy expanded at a record 20.1% yoy in 1QFY22, but 2-yr annualized growth was -4.7% (decline).Corporate earnings growth is continuing its strong show with consensus estimates pegging current financial year’s earnings growth at over 25% yoy. The corporate earnings to GDP ratio rose to 10-year high of 2.6% in FY21.It is well understood that India has some of the most favourable demographic trends in the world. India is now positioned to attract capital for investment that can aid productivity growth for the Economy. India is well positioned with an unlevered corporate, and household sector, improving RoIC supporting corporate sector valuation, and a balanced Current Account, that is turning structurally positive. The turbulence in China has been accompanied by resilience in EM ex-China trends. This trend is poised currently at a good launchpad for a durable takeoff. While India has 11.6% weight in the MSCI EM Index, the weight goes up to 17.4% for the ex-China version. This can be a catalyst for India flows.Over 50% of the Indian adult population has got at least one dose. Active cases are down 89% since the second wave peak is early May 2021, but have been inching up over the last fortnight.While longer term movements are guided by corporate earnings and economic growth, near term can get influenced by a host of variables – one of the major ones being liquidity. While we all are aware that the markets are impacted by liquidity, there is no objective number to it, nor is it listed somewhere. Money supply can be a good proxy for liquidity. We took the money supply of the top 13 countries / regions of the world and added them together to give us a close proxy of global market liquidity. A look at the chart below confirms the high degree of correlation between equity market movements in near term with liquidity (Global liquidity in blue, MSCI World Index in green).With key central bankers of the world continuing with their asset purchase programs, the liquidity continues to remain strong, at least in the near term. In a record low rate and high liquidity environment, economic recovery along with revival of corporate earnings growth bodes well for equity as an asset class. The global pile of negative-yielding debt has grown to more than $16tn. There is reasonable consensus that rates are at significant lows with virtually no room for further cuts. The Fed is expected to start tapering the asset buying program from the end of the year. This could put pressure on global equity valuations.Wholesale Inflation in India has been in double digits for the last 5 months – for the first time in 13 years. The gap between India 10-year yields and Repo is close to 10-year high – indicating that the market is not expecting a rate cut at least. RBI has maintained the accommodative stance, prioritizing growth.Even if rate hike cycle were to begin, it is interesting to note that Nifty delivered strong earnings growth trends during the past Fed hike cycles & market returns tended to track earnings growth. Continued growth momentum in initial stages of hiking could more than offset rate increases. The taper tantrum happened post May’13 comments from then-Fed Chair Bernanke while the tapering started in Dec ’13. INR sharply depreciated and the Indian market sold off ~12% over the subsequent 4 months.As per Bloomberg data, based on consensus estimates, Nifty is trading at one-year forward P/E 22.5x. This is 38% higher than 10-year median one-year forward valuation of 16.3x. In the last 16 years, only 2% of the times, Nifty has traded at a higher valuation than the current one. To that extent, Nifty is definitely trading at a significant premium to historical valuations and qualifies as expensive.Although, it’s a common practice to compare an absolute valuation with its history and then conclude whether it is expensive or not, we also look at current relative valuations and compare them with historical data.1-year G-Secs are trading at 3.87%. The inverse of yield is P/E ratio. Hence 3.9% yield translates into a P/E ratio of 25.8x. Hence, the same equity which is trading well above historical averages, starts looking relatively cheaper than debt (or fixed income). If history is anything to go by, equity markets have offered reasonable risk reward opportunities when its valuation has been lower than fixed income.As a result, as long as we are in a rising liquidity and low rate phase, the valuations can remain elevated and markets can remain buoyant for much longer than many think. One needs to closely follow the liquidity and rate turning points. Incrementally, investment positions would be better off with slightly reduced risk positions with allocations towards large cap and hybrid funds.(The writer is the Senior Fund Manager-Equity, PGIM India Mutual Fund.)