Sensex at 50,000! What justifies the valuations?

While Sensex scaling 50,000 gives us an opportunity to celebrate a milestone, the underlying fact is we have seen an unprecedented upside in Indian equity markets since the slide of March 2020. Let us analyse why 50,000 in January 2021 seems so normal, when many believed that the index may fall to 20,000 levels in the last week of March 2020 as the uncertainty of COVID-19 outbreak weighed supreme.

Firstly, in the last nine months, India has done significantly better than several countries in containing the epidemic. The number of new infections in India has continued to edge down even as many countries are experiencing a surge of second wave. While the government had announced a modest stimulus (approximately 2 per cent of GDP), the recovery momentum has been strong. Secondly, positive news flow on vaccination along with Biden's victory in the US elections have driven a risk-on sentiment globally. This risk-on sentiment has benefitted India as it has received disproportionately large share of foreign portfolio flows in CY20, due to better growth prospects. FIIs invested aroun $23 billion in Indian equities in CY20, even as most large EMs barring China reported FII outflows from equity markets.

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Thirdly, while the lockdown has hit the economy hard and GDP contracted by 23.9 per cent YoY in 1QFY21, the growth momentum recovered sharply in 2Q with GDP contraction of 7.5 per cent YoY in 2QFY21. High frequency data now points to YoY growth in many sectors. Further, employees with higher skills/higher income jobs had the flexibility of working from remote locations, even as workers with lower skilled/lower income lost jobs due to social distancing norms and other restrictions. As a result, the balance sheet of higher income households is fairly healthy and is driving discretionary spending.

The fourth factor is sharp rebound in corporate earnings in 2QFY21 aided by aggressive cost cutting measures and lower interest costs. The aggregate EBITDA of BSE500 companies jumped by approximately ~7 per cent YoY in 2QFY21 (vs ~27 per cent YoY drop in 1QFY21). Similarly, aggregate PAT grew by ~13 per cent YoY (vs ~30 per cent YoY decline last quarter).

The better than expected results are driving broad based earnings upgrades and the consensus estimates now imply that the aggregate PAT of BSE500 companies would grow by ~9 per cent and 33 per cent YoY in FY21 and FY22, respectively. In contrast, GDP is expected to contract by ~8 per cent YoY in FY21 and could grow by ~10 per cent YoY in FY22.

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While the financial sector was expected to report a sharp jump in NPAs after the stringent lockdown restrictions, the commentary of lenders on asset quality has surprised positively. Further, banks and NBFCs have raised more than Rs 90,000 crore via equity issuances in CY20 to prepare for a surge in bad loans. This has driven a sharp rally in bank/NBFC sector that accounts for more than a third of Nifty index weightage.

Some of the divergence between corporate earnings growth trajectory and broader economic recovery can be explained by market share gains of larger firms.

The last reason is that India's external account is in a very comfortable position. Current account surplus (~3.1 per cent of GDP in 1HFY21) along with strong capital flows have helped increase the forex reserves to $585 billion (vs $396 billion two years ago in January 2019). This is putting appreciation pressure on currency. The expectation of currency appreciation itself encourages foreign inflows, further aiding the equity rally.

The above reasons justify high valuations. Retail investors may invest via stock or mutual fund and SIP to beat volatility. One should look at sectors and specific stocks which have not rallied so far and will catch up as the economy recovers later this year. Always have a long time horizon to benefit from the stock market.

(The author is CEO-Retail at IIFL Securities.)

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