Indian stock market at risk of significant declines, report warns – ThePrint – ANIFeed

New Delhi (India), August 4 (ANI): Current market valuations in the country have reached levels resembling trends seen in 2007, according to a study by wealth management platform Nuvama.

“At such high valuations, we can expect five-year returns to be disappointing (<5% CAGR) with elevated risk of significant downside. Additionally, slowing earnings growth and potential risk of a US labor market recession suggest that we may be approaching a turning point,” it added.

Underlining the situation, it added: “A cycle of declining earnings has begun as profit growth coincides with anemic revenue growth.”

According to Nuvama, this situation further suggests that the slowdown in earnings growth and the potential risk of a recession in the US labor market may indicate that the market is approaching a critical inflection point.

According to the report, while strong market flows make it difficult to identify a top, relative valuations remain the main determinant.

The report highlights key indicators that reflect extreme valuations in Indian markets, adding that the market capitalization to GDP ratio is 150 percent, matching the peak in 2007.

The median price-to-book (P/B) ratio of BSE500 companies rose six-fold and return on equity (RoE) stood at 15 per cent, compared to the peak in 2007 when the ratio was 4 per cent and return on equity (RoE) was 25 per cent, it added.

Return on equity (ROE) is a measure of a company’s performance over a given period.

Additionally, the premium over emerging markets (EM) has doubled, from 50% in 2007 to 100% currently, it added.

Pointing to a worrying trend, the report added: “Of the 108 billion options contracts traded globally last year, 78 per cent came from Dalal Street, where retail traders account for 35 per cent of derivatives trading.”

“Derivatives turnover on NSE increased 30 times from Rs 247.5 lakh crore in March 2020 to Rs 7,218 lakh crore in March 2024,” it further highlighted.

After weeks of warnings from SEBI, RBI and FM, the market regulator has published a “consultation” paper proposing measures to curb trading activity in the options market.

The report quotes market regulator SEBI as saying, “The equity derivatives market in India is becoming a macroeconomic issue, not just a micro issue of investor safety. It is time to consider whether household savings are being diverted to speculation rather than capital accumulation.”

As mentioned in the report, market data reveals that the starting point of valuations explains 70-80 percent of the five-year returns, making it an invaluable guide in extreme market conditions. Markets often experience long consolidation phases, lasting 5-15 years, with significant declines after a bull run in a highly valued market. Notable examples include India (2007-2013), the US (2000-2012) and MSCI EM (2007-present).

The report also indicates that the improvement in free cash flow compared to 2007 partially offset the lower return on equity, but this is still a cautious result.

“While the improvement in free cash flow compared to 2007 partially offset the lower return on equity, we doubt this time will be any different,” the report added.

On the domestic front, however, risk appetite remains strong, with household equity exposure at an all-time high despite weakening income growth. Globally, rising risks of a U.S. recession could dampen risk appetite, while potential interest rate cuts amid a recession offer little solace, according to the report.

In light of these valuation concerns, the report suggests structuring portfolios based on valuations.

Nuvam’s recommendations include overweight (OW) in sectors with reasonable valuations such as private banks and insurance, defensive cash cows such as FMCG and telecoms, as well as sectors with high valuations but low earnings including chemicals, IT and consumer durables.

On the other hand, the report recommended staying away from sectors where valuations are high. The sectors where valuations have peaked are metals, autos and public sector units (PSUs). (ANI)

This report is generated automatically by ANI news service. ThePrint is not responsible for its content.