The market is currently grappling with two major constraints as it is trading at all-time high levels. Firstly the valuations have skyrocketed as stocks have gained sharply in the recent past. The price-to-earning (P/E) multiple of all major indices are at their record highs.While the Nifty is at 24x Trailing PE, the midcaps are even more expensive, hence Nifty-500 is at ~26x.Though index levels have moved up, there is no visible growth in earnings to support it.
In my opinion, for the market to further go up, the earnings growth has to pick up. The upside for the market depends on the growth trajectory of corporate earnings which is currently missing.
The second constraint here is the liquidity situation, which is creating a floor for the market. We are seeing unprecedented domestic retail liquidity coming into the market.
This is the first time we are seeing a huge shift in domestic retail asset allocation into equity which according to me is a good thing. In fact, this liquidity is keeping the market high currently. I would say that this change in attitude of domestic household in terms of investment into equity through mutual funds is a positive thing. Indian household savings were highly skewed towards physical assets like gold and real estate.
Now the trend is changing. And because of this shift I believe that $10-20 billion per annum of incremental flows will keep coming into equity from domestic retail investors and the bulk of this will be through the mutual fund route.
The amount may look high. But it is not if you consider our domestic savings rate of 30 per cent of the GDP. Even half to one percentage point increased allocation into equity will look high because of the historically abysmally low savings flow into equity from domestic investors. We have not seen this kind of flows till now so it is looking quite high.
The market participants should be prepared to deal with this kind of sharp flows into equity from now on. This huge liquidity from domestic investors is supporting the market and it would cap any sharp downfall for the market.
What could change the situation on the positive side is improvement in the earnings trajectory. If that has to happen then domestic consumption has to pick up, especially rural consumption, which has been lagging for the past four years. All depends on a broad-based economic recovery. I feel the focus areas will be consumption and affordable housing sector which could trigger accelerated growth for the economy and corporate earnings.
Disclaimer: The opinions expressed in this column are that of the writer. The facts and opinions expressed here do not reflect the views of www.moneyfront.in. This article was first published online on myDigitalFCdotcom. This article has been provided by Motilal Oswal.