On 3rd June 2024 Nifty closed at 23263. On 24th July Nifty closed at 24299. Two big events happened in between: the election results on 4th June and the Union Budget on 23rd July. The market had turned excessively volatile on 4th July and also dipped sharply intraday on Budget Day, 23rd July. But after the two events the market is back to normal. For a person who did not look at the market during 4th June and 24th July there was only a steady uptrend in the market. It is important to understand that the two events did not impact the market trend at all. If we look at the long-term trajectory of the market, this pattern holds true. Big events will come and go; but the market movements will largely be dictated by earnings growth. Hence the market dictum, “in the long run the market is a slave of earnings.”
It is important to understand the cyclicality of earnings growth. Corporate earnings move in cycles. During some periods corporate earnings rise sharply; during some phases corporate earnings rise very slowly. For instance, during the bull market of 2003-2008 which took the Sensex from around 3200 in May 2003 to above 21000 in early 2008, corporate earnings grew impressively by around 30 percent a year, providing fundamental support to the market rally. Corporate profit to GDP ratio surged from a low of 2.7 percent in 2003 to a high of 5.8 percent in FY2008. This boom in corporate profit ended with the Global Financial Crisis of 2008 and the Global Recession that followed. The bull market of 2003-08 also ended with the Global Recession of 2008.
The period 2011-20 was a period of tepid corporate earnings. Corporate profitability has been struggling during this period except in 2017. Consequently, Nifty delivered only around 8.5 percent returns during 2010-20. Corporate profit to GDP ratio has been steadily declining and touched a low of 2.1 percent in FY 2020. It has been rising since then. Corporate profits increased sharply from Rs 5.3 lakh crores in FY2020 to Rs 20.6 lakh crores in FY 2023. This is exceptional growth. Profit to GDP of Nifty 500 companies increased to a 15-year high of 4.8 percent in FY 2024. For the entire listed universe, the ratio rose to an impressive 5.2 percent. It is important to understand that in FY2024 corporate profit grew by 30 percent even while nominal GDP growth was only 9.6 percent.
In brief, the market will be driven by earnings growth in the long run. Big events will cause temporary sharp swings in the market. Investors should ignore these transient swings and continue to invest systematically for long-term wealth creation.
Seasoned investors, many fund managers and the regulator SEBI have been cautioning investors about the excessive valuations in segments of the broader market. But the excessive valuations are sustaining, supported by sustained fund flows and the exuberance of newbies who entered the market post-Covid. History teaches us that excessive valuations may sustain longer than most experts believe but will correct to normal valuations at some point of time. Therefore, it is better to err on the side of caution and opt for the safety of fairly valued largecaps.
