Stock Market: Battling valuations and risks

Stock markets look expensive on most traditional measures of valuation, trading at a significant premium to long-term averages. The wider market of small caps seems more overvalued. This comes even as significant risks lurk — rising inflation, earlier than expected rise in US interest rates, and a pandemic that is keeping a step ahead. Can the market rise over this wall of worry or will any of these events trigger a sharp sell-off?


However, the earnings to bond yield ratio is below its long-term average on a trailing basis which is supporting current market valuations as bond yields have come off at around 6%. Any pickup in inflation may lead to a spike in bond yields. Going forward, the broader market performance is likely to be in line with the global trends till evidence of medium-term acceleration in earnings starts showing, according to analysts.

• Nifty consensus EPS estimate for FY22 remains largely unchanged
• Earnings-to-bond yield ratio is below its long-term average on a trailing basis
• Rapid vaccination is expected beginning July, which reduces risks of lockdowns
• Inflation may be due to supply disruptions and cool down eventually

MULTIPLE RISKS

• Normalising US interest rates and Fed tapering could cap inflow
• There could even be outflows if rates in the US rise
• India’s own interest rates may rise faster as inflation hardens
• Higher bond yields and stronger dollars will dampen the markets
• A third Covid wave

COUNTERPOINTS

• Many segments trading at normal valuations
• Earnings are below normal; as they rise, overvaluation will correct