Consider a hypothetical scenario. A financial journalist is interviewing me in mid-May on the market outlook. The journalist asks, “If the BJP fails to get a majority on its own and we have a coalition government headed by the BJP, dependent on the support of other parties for political survival, how will the market react?”. The journalist continues with another question: “If the Budget of the new government raises the Short-Term Capital Gains Tax and the Long-Term Capital Gains Tax, what will be the impact on the market?” My simple answer to these questions would have been: “the market is likely to correct sharply by 10 to 15 percent”. Most market experts would have responded on similar lines. But look at how the market responded to these somewhat unexpected developments. Nifty, which was hovering around 22200 in mid-May, is now up by around 10 percent. It touched a record high of 25000 in early August.
Bull markets are known to climb many walls of worries. This bull market is exceptionally resilient, climbing many walls of worries in quick succession. Apart from the two mostly unexpected developments – an election mandate which fell short of market expectations and the Budget raising the capital gains tax – the market shrugged off the global sell off on August 5th triggered by recession fears in the US and the unwinding of the yen carry trade. Clearly, this is a formidable bull market. And we know from experience that bull markets can surprise on the upside.
Bull markets cannot sustain without fundamental support of economic growth and earnings growth. The ongoing bull market has this fundamental support. India has been the fastest growing large economy in the world during the last three years and is well set to retain that status this financial year too. Corporate earnings have been decent though decelerating recently. More important, the tailwind from the global market rally is also strong. But the formidable single factor driving this bull market is the domestic fund flows into the market. DIIs and the continuously growing tribe of exuberant retail investors have become a formidable force in the Indian market completely eclipsing the FIIs who used to call the shots in the not-too-distant-past. Sustained FII selling is easily getting absorbed by domestic investor buying.
The explosive growth in the number of demat accounts continues. Monthly gross SIP inflows touched Rs 23332 crores in July. This sustained money flowing into the market ensures that all dips are getting bought. In the near-term, this trend is likely to continue imparting resilience to the market.
The only concern is valuations, which remain elevated. Nifty is now trading at around 22 times FY25 estimated earnings. This is higher than historical averages. Market cap to GDP at above 140 percent is very high. Valuations in the broader market, particularly in midcaps, are hard to justify. Sustained fund flows into the mid and small-cap schemes have pushed up valuations in these segments posing challenges to fund managers.
The challenge before investors is how to reconcile the elevated valuations in the market with their investment goals. For long-term investors, high valuations pose no challenge. It makes sense to remain invested in this bull market and continue with systematic investment. For investors with a limited time horizon, some profit booking can be considered if that helps in realizing the financial goals for which the investments were done.
