Markets Gaining Valuation Flab from Retail Binge?

George Soros Quote of Market Overvaluation
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Synopsis: The Covid-19 Pandemic has shaken the world like never before. Stock markets have been no exception. In this article, we deep-dive into how global markets in general and Indian stock markets in particular have reacted to the pandemic so far, and particularly how the valuation look at the beginning of Oct 2020.

The world has been weird this year, in more ways than one. The year started with warnings of a looming pandemic outbreak, with China already reeling under its effects by early January 2020. Of course, the rest of the world watched the news, while sipping on their coffee, snugly believing that something like that will never happen in their own countries and cities. That confidence was spilling over to Wall Street and stock markets around the world in Europe, Asia and India, where stock indices were making new all-time highs, right through January and February of 2020.

In February, the trouble spilled over to Europe, starting with Italy. As the cases started to explode, in Feb, Italy realised that the threat of pandemic is very real, and it had in fact reached their very door-step. With its porous boundaries, it was only a matter of time before the disease spread rapidly to other parts of Europe, and so it did rapidly to UK, Germany, Spain, France and dozens of other Eurozone countries. By March, the continent was reeling under the impact of pandemic. Of course the fear set in, and the stock markets took a cue, and started to melt-down rapidly, in perfect synchrony, right across the world. As vast number of counties started imposing unprecedented lockdowns, shutting down entire countries and economies, the markets worldwide panicked and made lows worldwide on 23rd March 2020.

The very next day, on March 24, the fed stepped in with its ‘Elephant Gun’, a bazooka fiscal stimulus amounting to 2.3 Trillion dollars. Almost on cue, the stock markets started recovering immediately. With several other major central banks (Japan, Germany, UK, France, Italy) announcing similar massive stimulus packages, stock markets worldwide made rapid recovery in the coming 5 months to be almost at pre-covid levels. Without exception, every single major stock index worldwide Nasdaq, Dow Jones (USA), DAX (Germany), FTSE100 (UK), CAC(France), NSE / BSE (India), KOSPI (Korea), Nikkei (Japan), Hang Seng (HK), by August, each one of these had recovered to levels better than or only slightly lower than their respective pre-covid highs.

Contrary to the sentiment on the Wall Street, the mood on the real street has been subdued and even negative. Economists world-wide have been unequivocal in their concerns that the pandemic has taken a huge toll on the real economy, and it would take a few quarters for the complete recovery. The toll on the of real economy is visible every day in across a slew of macro-economic indicators – unemployment figures, decline in credit growth, moratorium figures, IIP figures, Indirect and direct tax collection figures, Exports, GDP Data, Fiscal Deficit, Government debt, all of the indicators have been negative for the economy.  Despite all this, the stock markets have been going only one way – up and up, defying the conventional wisdom and current overwhelming reality that the economy is the biggest victim of the pandemic.

Data or Plain Gut Feel?

So, can we in some way measure how irrational a trend has this been, and continues to be with every passing day?  Let’s look at this very objectively, with the help of some data.

SrDateNifty 50 P/ENifty50 % Change from Jan20 HighsNifty 500 P/ENifty 500 % Change from Jan20 HighsNifty 50 EPSNifty 50 EPS % Change from Jan20 Highs
11-Oct-201926.170%27.910%4340%
215-Jan-202028.639.40%31.4311.19%431.13– 0.66%
323-Mar-202017.15– 40.09%19.45– 61.59%443.752.92%
417-Jul-202028.550%31.210%381-11.60%
501-Oct-202033.1815.89%41.1531.85%344-20.18%
Table 1: Nifty 50 Vs Nifty 500 Vs Nifty 50 EPS – Oct-2019 to Sep-2019
Figure 1: Nifty50 PE Vs Nifty500 PE Vs Nifty50 EPS 01-Oct-2019 to 01-Oct-2020 In Percentage Terms

As we see from above chart, on 01-Oct-2019, Nifty50 had an EPS of Rs 434, and PE of 26.17. On the same day, Nifty500 PE was 27.91. Even at this point, the markets were overpriced, as at index level, anything upwards of 22 PE is generally considered expensive. After the strong bull-run seen in 2017, the markets had fallen significantly in 2018 and 2019 due to falling growth in the economy. This is seen in subdued earnings, and that in turn reflects in higher multiples, making the markets more expensive in the short term.

Figure 2 – Nifty50 PE Vs Nifty500 PE Vs Nifty50 EPS – 01-Oct-2019 to 01-Oct-2020 [EPS in Real Terms, as on 01-Oct-19]

Similar to figure 1, this chart shows the EPS in real terms (instead of change in percentage from base of 0 on 01-Oct-2019).  It’s very apparent that the EPS has been in a rapid decline since May 2020, as the Q4 FY20 results started streaming in, post the first 6 weeks of nation-wide lockdown, and continue to slide down rapidly, as the results of Q1 FY21 continue to stream in through July, Aug and Sep 2020.

We have a Global Pandemic, The World is Ending Soon!

Figure 3 – Nifty50 PE Vs Nifty500 PE Vs Nifty50 EPS – 01-Oct-2019 to 01-Oct-2020 [In Percentage Terms, as on 23-Mar-20]

By 23rd March 2020, the peak of Covid panic in stock markets worldwide, the Nifty50 PE had fallen off the covid cliff, plunging down to 17.15 and Nifty500 was down to 19.45, down by 30% and 34.5% respectively from the levels seen on 01-Oct-2019.

Figure 4 – Nifty50 PE Vs Nifty500 PE Vs Nifty50 EPS – 01-Oct-2019 to 01-Oct-2020 [EPS in Real Terms, as on 15-Jan-20]

Meanwhile, just prior to the covid outbreak, the world markets were peaking to all time high levels. Nifty too was within touching distance (12,343) of its all-time high (12,416). As we see from chart above, on that day, the Nifty50 PE was also peaking at 28.63 and so was Nifty500, at 31.43 levels.

Covid? Its just a Flu! How can it ever hurt the Global Economy?

Figure 5 – Nifty50 PE Vs Nifty500 PE Vs Nifty50 EPS – 01-Oct-2019 to 01-Oct-2020 [In Percentage Terms, as on 10-Jun-20]
Figure 6 – Nifty50 PE Vs Nifty500 PE Vs Nifty50 EPS – 01-Oct-2019 to 01-Oct-2020 [EPS in Real Terms, as on 30-Jun-20]
Figure 7 – Nifty50 PE Vs Nifty500 PE Vs Nifty50 EPS – 01-Oct-2019 to 01-Oct-2020 [EPS in Real Terms, as on 17-Jul-20]

These 3 charts reveal that by mid-July, the stock market recovery was almost complete. The Nifty50 PE was back at 28.55 and Nifty500 was at 31.21 level on 17 July 2020. Please note that this was, despite the steep fall seen on Nifty50 EPS, down to 381 (from 431 seen on 15 Jan 2020), a steep drop of 11.6% in past 6 months, with the worst in earnings still to come.

Figure 8 – Nifty50 PE Vs Nifty500 PE Vs Nifty50 EPS – 01-Oct-2019 to 01-Oct-2020 [In Percentage Terms, as on 01-Oct-20]
Figure 9 – Nifty50 PE Vs Nifty500 PE Vs Nifty50 EPS – 01-Oct-2019 to 01-Oct-2020 [EPS in Real Terms, as on 01-Oct-20]

Since July 2020, as the glut of liquidity has taken the indices ever higher, every passing week. August and September have seen the indices continuing its relentless upward march. By 30th Sep 2020, the PE of Nifty50 has now risen to 33.18 and Nifty500 PE has risen to an astronomical 41.15. Of course, all the while, as results of Q1 FY21 have been trickling in, Nifty50 EPS has been constantly falling downwards, settling at about 344 on 30th Sep 2020, down by over 20% from the EPS of 431 on 15 Jan 2020.

What’s worse, is that the Nifty500 PE has expanded faster compared to Nifty50. That clearly means that the broader market is now starting to put on valuation flab faster than the top 50 nifty heavy-weights.

So besides the unbridled optimism that the world economy is witnessing a V shaped recovery, and the covid troubles will be obliterated with the quick arrival of a vaccine by the end of 2020, what is really fuelling this rally? One factor that often comes up as a possible explanation is that excess liquidity is driving the markets. So let’s look at the transaction figures of FII and DIIs the large entities that traditionally have always driven the transaction volumes in the stock market.

MonthFII Net Purchase / SaleDII Net Purchase / Sale
March 2020-62,43328,891
April 20202,448-7,153
May 202013,0004,977
June 202023,289-3,689
July 20208,590-7,231
Aug 202037,846-9,339
Sep 2020-5,689-2,920
Total17,0513,536
Figure 2: FII & DII Transaction Volumes Since March 2020

What does the data tell us? Since the crisis broke out around Feb-end, the FIIs panic-dumped equities worth 62000 Cr in March 2020. Since then, they have been gradually purchasing every month. Yet, through the 7 months between Mar to Sep 2020, they have had a net purchase of only Rs 17,051 Crores (roughly 2.27 Billion USD, with INR @75). Similarly, the DII net purchase has been a paltry Rs 3,536 Cr (Roughly 471 Million USD, with INR @75). FIIs and DIIs put together have pumped in roughly 2.74 Million) in these 6 months. In a market with total capitalisation of close to 2 Trillion USD, that’s less than 0.2% value, and is likely to barely move the needle, as far as market valuations are concerned. Just for perspective, FIIs had infused 1.28 lakh crores in equity in 2012 (roughly 19.69 Billion USD @65 INR), 1.13 lakh crores in 2013 and 97,000 Crores in 2014. Of course, the figure of 17,000 Cr above is only for 6 month of the fiscal year 2021, yet even if annualised, the flows are nowhere near the massive inflows India has witnessed in the past.

So, what then is fuelling the rally? US federal government had pumped in a massive 2.3 Trillion USD package around end of March 2020, and large part of it was the $1200 cheque per month given to every person who was eligible. Over 3 to 4 months, several hundred billions were distributed directly to peoples’ bank accounts. Similar, massive fiscal stimulus packages have been announced by dozens of countries, across the world. All the money pumped in by the central banks all over the world, is finding its way into the hands of people, who are happily investing the money back into the beaten-down markets.

Of course, India did not have a direct fiscal stimulus approach, so there was no free cash to its citizens. However, India has always been a country of savers. A lot of that money is now flowing into the Stock markets. There has been a big flare-up in the fresh demat accounts opened since the lockdown started in late March 2020.  CDSL alone has added 50 lakh new demat accounts since Feb 2020, till first week of September 2020. NSDL does not release new addition figures, has added significant numbers. Just for perspective, CDSL’s 5 million new accounts in 7 months, more than what the country added in whole of previous year (4.9 million Demat a/c added in last fiscal). Another perspective to highlight this sheer pace of this surge – Till Jan 2020, CDSL’s demat account count was 2 Crores, so, in only 7 months, it has added 25% to its existing base, which it took 5 years to build!!  In months of peak pandemic, NSE’s transaction volumes shot up by up to 50%!! Retail investors have clearly, driven this rally, all on their own steam.

But, that’s also the riskiest bit. At lofty P/E, markets remain at historically highest valuations, and typically, the retail investors are the last to participate in a bull run, and that’s when the markets top-out. Now, will this time be different? Hard to say, but one thing is for sure, market is on a binge, and showing all the signs that a major correction is not too far.

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