Barring the shock that we received on the last day of August due to geopolitical tension, RBI not extending the moratorium period, and SEBI imposing a new margin system, stock indices had a smooth ride in August. One of the arguments supporting the rally in the market is that excess liquidity across the world with lower interest rates makes equity as an asset class an obvious choice. Many experts suggest that THERE IS NO ALTERNATIVE (TINA) TO STOCK. This is despite valuations have become rich.

I firmly believe that any market to have a sustained rally needs two primary ingredients-earnings growth and liquidity. The period between 2003-2007 had both these ingredients, and hence we had a sustained rally. But in the present rally, there is liquidity, but there is no earnings growth. On the contrary, we see earnings degrowth. For June 2020, India Inc has observed earnings degrowth of 63 percent over June 2019! The GDP data that came yesterday shows that the first quarter of GDP shows a 23.9 percent contraction. This amply tells the effect of lockdown on India’s GDP and Corporate India.
Over the last few years, India Inc’s earnings growth has been below the nominal GDP growth rate suggesting that India Inc has struggled to report growth. The GDP is likely to contract in FY21, which will have a telling impact on India Inc earnings for FY21. I am not in the camp that believes that India Inc’s earnings will bounce back in the second half of FY21, and FY22 will be the usual year. Till we have a successful vaccine, it will be hard to expect that we are going back to normal. Trials are on for vaccine, but there is no guarantee that we will have vaccines by the last quarter of 2020. Hence my understanding that the virus will impact the Indian economy not for one or two quarters but a more extended period.

The present estimate is that Nifty 50 will have an EPS of Rs 650 for FY22. Based on that earnings projection, Nifty is trading at 17.5x. This is a rich valuation. Going by the past trend, we have realised that earnings growth projections are on the higher side, and I will not be surprised that a similar trend will be maintained for FY22 projected earnings. This rally is only on one leg, and that is liquidity. With one leg, one can’t cover a long distance. And even liquidity seems to be drying up at least from mutual fund investors as there was outflow for the month of July-first time in the last four years. FPIs money is hot money, and they can change the trajectory at any moment. Hence assuming that liquidity will last, needs a revisit.

But I am not alone in the camp of worry. The widening gap between the economy and the stock market is a matter of concern. Very recently, RBI governor Shaktikanta Das also expressed concern about the disconnect between the economy and the stock market. In an interview with one of the business TV channels, he said,” There will definitely be a correction but we can’t say when.” Even the SEBI Chairman “perplexed” by the surge of retail investors in the market.
What makes me worry is that recently we have seen companies having zero turnovers but reported smart gains on the bourses. This is normally observed when the market is at its peak. Many counters have reached in bubble zone. The rally in many small and mid-cap companies are driven by the retail investors who usually act based on tips rather than research. Vested interest is pushing the prices high and hence call for caution.

In the last couple of months, I have sounded cautious. I continue to have a cautious view. This is despite the market has proved me wrong in the last few months. Timing the market is not an easy thing, and not many could do it. Hence wherever as an investor, you are making decent money, you should evaluate your option of booking profits. The scrip may move up post sell, but don’t lose your heart as you have made money. The same way doesn’t be in a hurry to park a lot of funds at one go. I know few investors have borrowed money to ride this rally. They are sitting on thin ice.

Investors typically lose their heads before they lose their shirts. We are not far from the days when investors will lose their shirts too.