The Indian stock market has been on an encouraging bullish run in recent months. Only recently, in mid-July, the Nifty 50 hit a fresh high and surpassed the 24,600 mark. As the market continues its upward trajectory, investors and analysts are pondering the question: Are Indian equities overvalued or is there still room for growth.
As opinions for both sides of the discussion gain strength, Nilesh Sharma, Executive Director & President at Samco Securities, offers a rational take on how investors can use the Buffett Indicator — or the market capitalisation to GDP ratio — to better assess the current market scenario.
India’s Market Cap to GDP Ratio: A Concerning High
As of May 2024, India’s market capitalisation to GDP ratio scaled to a 15-year high of 140.20%. This figure is significantly higher than the previous 13-year high of 115% reported in 2023 and understandably raises serious questions about the current valuation levels in the Indian stock market.
Speaking of the current market scenario, Samco’s Nilesh Sharma observes:
“With the Nifty breaching 24,600 and the Buffett Indicator hitting a 15-year high of over 140%, the Indian stock market’s trajectory presents a complex challenge for investors. While these levels may undoubtedly raise concerns about overvaluation, it is also crucial to view them in the context of India’s robust economic fundamentals and future growth potential. However, investors should exercise caution because a market capitalisation to GDP ratio of this level leaves little to no room for error.”
Sharma’s advice comes at the right time because any negative surprises at this juncture could lead to significant volatility. In this environment, traders and investors must focus on selective stock picking and focus on quality over quantity.
Comparative Analysis with Other Markets
To put India’s market capitalisation to GDP ratio of 140.20% into perspective, let us compare it with the Buffett Indicators of other emerging markets.
Indonesia: 55.80%
China: 61.30%
Thailand: 104.40%
South Korea: 106.50%
These figures, valid as of December 2023, provide a stark contrast to India’s current valuation levels.
Implications of India’s High Market Capitalisation to GDP Ratio
India’s high market cap to GDP level raises several crucial points of concern, as outlined below:
Overvaluation Concerns: The current ratio means that investors are extremely optimistic about future growth prospects or that speculative forces are at play.
Potential for Correction: Historically, when markets reach such elevated levels, it increases the possibility of a market pullback.
Earnings Growth Pressure: To justify these valuations, Indian companies will need to deliver exceptionally high earnings in the coming quarters.
Domestic Investor Frenzy: The high ratio could also partly be driven by increased participation from domestic retail investors.
Decoding Nifty at 24,600+ With PE Ratio Analysis
As of July 16, 2024, which was the same day the Nifty surpassed 24,600, the index’s P/E ratio stood at 23.39. This is around the same level as its TTM P/E of 23.17 (as of December 31, 2023) but above its average P/E of 20.82.
The slightly elevated P/E ratio indicates that investors are willing to pay more for each rupee of earnings — reflecting optimism about market growth in the future. However, the sharp disparity between the moderately high P/E ratio and the extremely high market capitalisation to GDP ratio is noteworthy.
Samco’s Nilesh Sharma tells us about the factors that may be contributing to this divergence,
“In the past, more specifically in 2021, we have witnessed the Nifty’s P/E ratio breach the 40-point mark too. However, the strong earnings growth recorded in recent quarters may be keeping the P/E ratio from reaching such extreme levels despite high market capitalisations.
We should also recall that the Nifty 50 also represents only the top 50 companies in the NSE, while the market capitalisation to GDP ratio considers the entire market. This may suggest that mid-cap and small-cap stocks may be seeing higher valuations than justified.”
This sheds more light on how investors can interpret the current market capitalisation to GDP ratio and P/E ratio.
Navigating High Valuations with Caution
It remains to be seen whether the market has room for more upside or if a correction is on the horizon. Given this uncertainty, the margin for error is slim and investors should approach the market with caution. Diversification, sectoral and geographical, remains the need of the hour.
For traders, it is also imperative to monitor various facets of economic news and reports before entering a new position or exiting a current trade. Tracking the economic and technical indicators is easy on the Samco trading platform, which offers users access to live market data at their fingertips free of cost.
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