IGI Logo

2023 ended on a high. GDP estimates held on and with interest rates stabilising, it led to a "goldilocks" kind of scenario. Lack of earning downgrades despite headwinds in IT and Consumption was the key for equities. We had expected the markets to be broad based at the beginning in 2023 as investment cycle recovery across private sector and real estate recovery was truly underway after kicking off in 2022. In addition, India's ever improving position as an important player in the realigned supply chain dynamics over the next decade is real and there is enough evidence of it in our interactions with the corporates across sectors especially manufacturing. Notwithstanding the above tailwinds, the intensity of market breadth in 2023 beat all expectations as mid and small caps led the broader indices (Nifty 500) to significantly outperform the large cap ones (Nifty50, Nifty100) during the year.

Infact, it is interesting to observe that all the "visible" risks in the markets at the beginning of 2023 have either faded or markets have become accustomed to it. Please note that the risks have not completely gone away but the perceived probability of it materialising into a market-changing risk-off event is much lower now.

a. Russia-Ukraine war (and the Israel-Hamas conflict) are likely to be long drawn out with lower chances of escalation beyond the immediate boundaries

b. The general elections in 2024 – much more belief in stable and strong government coming back post the state elections

c. While economic strength in US despite rate hikes has been surprising, Fed is likely to press any further hikes although elevated budget deficits might keep the bond yields elevated vis-à-vis pre-Covid levels.

d. The risk of a financial accident played out partially with the US mid-sized banks but the impact was contained.

How high can Nifty PE Ratio go?

The relative lack of perceived risks at the beginning of 2024 therefore begs the question - How high can Nifty-50 PER go?

We look at the long term history of fwd PER for Nifty 50 and its interesting to note that during the last period of sustained investment cycle and moderately declining interest rates, the PER peaked at 22-23x as compared to present levels of 20.5x.

While the above chart makes the case for further upsides in 2024 (especially large caps) with reduced chances of a sharp correction, we also believe that it is important to watch out for signs of a bubble. No two bubbles are the same. History does not repeat but it rhymes. We have therefore identified a few of those warning signals from our past experience (especially 2008 given the similarities in the economic cycle). Investors should monitor the below and use it as an input either for asset allocation or category allocation (within equities).

1. Option value: In the 2008 cycle, the valuation targets had started ascribing value creation from projects that had not even started or ascribing simplified valuation multiples to estimate the option value. In these cases, valuation targets of companies start moving from traditional parameters (PER, EV/EBITDA) to option values based on opportunity size. Typically, such valuation methods accompany sharp price movements based on simple announcements of market entry or expansion by companies. As an example, we are seeing signs of these in the electronic manufacturing space recently.

2. Holding company discounts: In the last leg of the bull markets, the holding company discount narrows significantly vs. the historical mean. The price movement of listed holding companies therefore is usually a good indicator of where we are in the bull market cycle.

3. Quality of IPOs: There has been a spate of IPOs recently, however, the quality has been reasonable with decent management track record. While the valuation in some of the IPOs can be questioned, nature and quality of businesses has been by and large robust. Most of the bull markets end with a large IPO with i) questionable quality and/or ii) stretched valuations. We feel that at least one of the two factors is not a risk as of now.

Above views are of the author and not of the website kindly read disclaimer