Market View 2018 Is The Market Overvalued?

Sanjiv Mehta  |  2018-04-14

2017 Economy & Markets

Indian economy performed well, it grew faster than that of most big nations. Inflation was well controlled, the government’s finances were sound, foreign investment boomed and stock indices soared in 2017.

Sensex went up from 26626 to 34010, a rise of 27.7%. 10 year bond yields went up from 6.4 to 7.3 and Indian Rupee strengthened from 67.91 to 63.85/1 $.  Though Sensex is at an all time high, corporate earnings have not picked up much, thus taking the valuation ratios to very high levels. Therefore for 2018 view, the most important questions are what happens now from these high levels and what actions should an investor take- whether to realize profits maintain or even increase the existing equity allocation.

A major development in 2017 was a much higher percentage of savings going towards financial instruments. Real estate remained depressed, on an average the prices fell by 3% mainly due to poor demand, demonetization, real estate regulation act (RERA) and GST. Share of affordable housing among new launches rose from 53% to 83%.  RERA though is proving to be a silver lining, areas where RERA has matured, an uptick in sales is seen. Although Gold moved from Rs 27445 /10 grams to Rs 29070, it has generated close to zero returns during the last 5 years, price in Jan 2013 at 29454 was actually higher than in Jan 2018.

Recommendations given in my Market View 2017 posted on January 31, 2017 were very effective, and portfolios managed by us yielded impressive returns. Advice to move a higher proportion of savings to financial instruments was very useful. Equity dominance in investments with a time horizon of more than 3 years was productive. Moreover, the sectoral calls on banking and infrastructure, and selection of good small and mid cap schemes contributed a significant alpha returns. For 1-3 years money, our recommendation of investing in balanced funds rather than duration plays (which performed badly because of bond yields going up) proved beneficial.

2018 Indian Economic Forecast

Most of economists feel that India in 2018 will grow at a faster rate as compared to the previous year. Macroeconomic fundamentals are very good. Twin deficits of Government finances and current account are well contained .Inflation is under control. RBI might not cut rates further but is not likely to increase interest rates for some time. The short term negative effect of demonetization and GST introduction seems to have been absorbed, second half of 2017 showed some acceleration as compared to the first half. India is expected to be the fastest growing large economy and the forecasts range from 7.2 to 7.5%.

Corporate earnings growth is an important factor for determining the resilience of high levels of stock indices.  A good way to analyze is to divide companies into two groups- stable group where earnings growth rate is stable for long periods of time, second is cyclical group which shows lots of variability from one cycle to another. In spite of favourable  domestic and global macro economic factors, cyclical sector has shown very low earnings growth in the years 2014-17.Causative factors include oil prices going down substantially in 2015-16, reduction of prices of commodities and metals, intense competition in telecom sector and increased provisioning required for banks. In 2018 we expect a long awaited pick up in earnings of cyclical group because of improvement in corporate banks performance, steady commodity prices and stabilization of telecom sector. Index earnings growth could be in the range of 17-18% for the next 3 years. Additionally, Index P/E ratio might have a new higher normal because of a changed composition with a lower representation of cyclical group which traditionally trades at a lower P/E.

2018 Political Scenario

As 2019 approaches, little stands between Mr. Modi and a triumphant second term. Perhaps, most importantly for voters, Mr. Modi’s government is less corrupt than the one it replaced. It has also worked hard to clean up India’s act, fixing shoddy infrastructure, chasing tax dodgers, tweaking laws to make the bureaucracy less onerous and targeting aid more effectively towards the poor.

However, there is just a little hint of anti-incumbency- BJP won the recent elections in Gujarat but with a much lesser number of seats. So, is the validity of half empty view on the rise? The opposition has raised the issues of GDP growth, industrial production and domestic investment being consistently below the expected equilibrium rates in India.  Inadequate job creation is another major issue and gives rise to the debate whether India will have a demographic dividend or disaster. Banking NPAs not being addressed timely is another important area. Additionally, BJP faces the risk of losing its strong constituency among the merchant and middle classes because of demonetization and hasty rollout of GST.

In 2018, state elections are in 8 states. With national elections in 2019, these assume importance. These states include Karnataka, Madhya Pradesh, Rajasthan and Chhattisgarh. Any adverse result for BJP has the capacity to unsettle the markets.

2018 Social Factors

Ever since BJP assumed power in 2014, there is almost a continuous struggle between secular pluralists and Hindu nationalists. Polarisation has grown starker and more violent.  There have been incidents of lynchings of Muslims, assassinations of leftist intellectuals and a broader intolerance of dissent.

Finance Doctor’s overall 2018 view

There are challenges but more likely outcome is India’s economy will recover from shocks and right itself in the coming year. Therefore my view is that Indian economy will grow faster than the rate in 2017.

Corporate earnings are also showing early signs of revival and that could turn into a good sustainable trend.

For 2019 elections, we are keeping a watchful eye on Mood of the Nation poll, other important surveys and of course the 2018 state elections. BJP and Mr Modi seem to be much ahead of their rivals at the current juncture. Even if certain state elections throw some surprises, there is a high probability of political stability for India during the next few years.

Socially, the intolerance and related unfortunate incidents are likely to be sporadic and piecemeal. Mr Modi is aware that a bigger eruption could prompt a bigger backlash against the ruling party. His recent speech at the opening plenary session of World Economic Forum, Davos emphasized the plurality and diversity of Indian way of life.


Based on above belief, my recommended asset allocation for maximising the benefit of our savings is following:

  1. For money with a time horizon of more than 3 years, equity will be very good.  Money should be allocated to large cap, mid cap and small cap schemes.Although it is currently felt that mid cap and small cap are stretched, our detailed analysis shows that in the Indian market, small and mid-cap schemes deliver a much higher return over a long period of time taking into account all up moves and down moves.  Schemes have to be carefully selected with a consistent performance over varying periods of time and a good track record of alpha generation. There should be a small sectoral allocation to banking and infrastructure sectors.
  2. For money with a time horizon of 1-3 years, balanced funds with a mix of equity, equity derivatives and debt will be good, since tax treatment being similar to equity funds is better than that of debt funds. Additionally, even in a down market, they hold their value well on a comparative basis.
    10 year bond yields have increased in the last year from 6.4 to 7.3 %. Bond yields are in a neutral area but the risk-reward for a duration play in the year 2018 is still not attractive and therefore should be avoided.

  3. For 0-1 year time horizon, short-term accrual and liquid debt funds are a good alternative. For people requiring monthly income stream, an SWP (systematic withdrawal process) could be structured in a tax efficient manner.
  4. Real Estate is expected to fall and might stabilize in about a year’s time providing a good buying opportunity later. It is possible that affordable housing segment might do better. Therefore, my recommendation will be to wait and watch. In the interim, grow your savings in financial instruments which are expected to outperform.
  5. Gold- As I have always written, historical returns of Gold are very low , although periodically it does go through fairly long period s of appreciation and then can decline for quite some time-long term overall trajectory is almost flat. Therefore, invest only that proportion of savings which fulfils your real gold requirement and not as a return enhancer.

Disclaimer – Timing of any market view or movement is difficult to predict and there are always risks to any view. However, an overall view based on clarity of multiple factors helps us in right asset allocation decisions. The efficacy of such an allocation sometimes might not be evident in short term but it is generally beneficial over a period of time.