Is The Indian Stock Market Headed For A Crash?

Published on:Oct 31st, 2017

“What we learn from history is that people don’t learn from history” – Warren Buffet

The current price to earnings ratio of Nifty is not very far from the one during the height of the Bull Run in January 2008. With a current PE ratio of 26.74, the Nifty requires just about a 5% gain to reach the all time high Nifty PE of 28.25 reached in January 2008. Now let us try to compare and contrast the situation in 2007 and 2017.

Source: mining.com

FIIs vs. DIIs

The current market is driven by Domestic Institutional investors (DIIs) whereas the 2003-08 bull market in India was driven by Foreign Institutional investors (FIIs). To put this in perspective, in 2007 FIIs pumped in 17 billion USD whereas DIIs had invested only 1.5 billion USD. In contrast, as of October this year, the FIIs have invested only 5 billion USD but the DIIs have invested a mammoth 14 billion USD.

This is very important to note as the crash in 2008 in the Indian stock market was caused by an external shock, the sub prime mortgage crisis in the US. As the crisis unfolded in the US and other developed markets, FIIs pulled their money out of the Indian markets causing the markets to crash. The high valuations the Indian markets were trading at only precipitated the fall.

The DIIs are considered to have a longer time horizon than the FIIs and this bode well for the markets. Moreover the factors affecting their investment decisions are more domestic and an external shock might not alter their investment strategy greatly.

Earnings Growth

The Indian corporate sector was on a stupendous growth trajectory through the run up to the crash in 2008. For the three-year period ending December 2007, Nifty earnings had grown at a CAGR of 17%. For the three-year period ending September 2017, the same number has been more or less flat. This points out to exuberance in the market that is not supported by the fundamentals.

Interest Rates

The benchmark interest rates are similar at about 6%. But the comparison ends there as the interest rate trend in 2007 was rising but in 2017 it is a downward trend. And as the inflation is well under control, a rate hike is not expected anytime soon but on the contrary there might be further cuts. This can drive the stock markets even higher.

US Stock Markets

The S&P 500 is trading at 25 times earnings. Given this rich valuation in the US stock markets, there could be a correction. The impact of this correction if it is to occur, is uncertain on the Indian stock markets.

To conclude, it is clear that the Indian markets are overvalued and it is not a great time to invest further in the stock markets. The lack of earnings growth seems to be the biggest concern. Having said that, as the current stock market is driven by DIIs, who are considered to have a longer time horizon than the FIIs, we might not see the kind of crash that we saw in 2008, when the markets fell by about 60%. But a correction to the extent of 20 to 30 percent is highly probable. But when this will happen is anybody’s guess.

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