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3 reasons you must curb high expectations in 2015
What a year 2014 was for the stock markets. The Sensex jumped a whopping 30% last year. Naturally, optimism is high about the stock market's performance in 2015. Especially since the economy seems to be on the mend and the government continues its reform agenda.
However, analysts advise investors to tone down their expectations of a high market return this year. This is especially so in the next few months.
Here are three reasons why:
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High valuations:
Share prices rose significantly in the recent past in anticipation of an improvement in corporate profits and economy. As a result, stocks currently have high valuations. This is measured by the Price to Earnings (PE) ratio, when the stock price is divided by the company's earnings per share. It shows how much an investor is paying for every rupee of profit earned by the company. The one year-forward PE is currently estimated at just over 16 times. This is the highest it has been since January 2011 and close to fair valuations. "We find valuations of quality stocks in high-growth sectors quite expensive and see risks of downgrades to earnings in case of certain sectors such as automobiles and industrials if economic recovery is weaker than our expectations," according to a Kotak Securities report.
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Positive factors discounted:
Today's share price is a reflection of tomorrow's growth. Indian markets have already discounted a slew of positive factors like a cut in interest rates or better economic growth prospects. This could limit the bull-trend in the near future. Only a higher-than-expected rate cut could set the markets on fire. However, the chance of a large rate cut is unlikely, especially considering the RBI's wariness. The rate cut also depends on factors like rupee-dollar movement, global crude oil prices, improvement in exports and domestic inflation. Moreover, the Federal Reserve plans to increase its interest rates in the US. This could negatively affect Indian markets. In anticipation of such a move, the RBI could very well prefer to take a cautious stand.
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Government reforms:
Companies need capital to produce goods and services. Once it earns money from selling the same, it pays back the money borrowed. However, it has to pay an extra interest for the capital borrowed. This is called interest expense. It also eats into profits. A high or rising interest expense is detrimental to profits. It shows that the company is paying more and more to service its debt. It is better to compare with the growth in profits and revenues. If the rise in interest expense is greater, then it is quite likely that profit growth will slow down in the long run.
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Pre-tax income:
The Narendra Modi-led government is one reason for the market's bull-run. It announced a slew of reform measures at timely intervals last year, cheering the markets. Major economic reforms could be stalled as the government does not have majority in both houses of Parliament. However, reforms are not the only factor concerning markets. The government's fiscal deficit is still a big issue. This is the amount by which the government spends more than it earns. A high fiscal deficit is bad for the economy. The government, in its maiden budget, targeted a fiscal deficit of 4.1% of the GDP or Gross Domestic Product - a measure of the economy. However, reports suggest that the government has already touched 99% of this amount. This throws doubts about the ability to meet its target of 4.1%. If it overshoots the target significantly, markets may not take it kindly.
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# 15.7%
The net profit growth of the 50 companies that form the NSE Nifty is expected to grow 15.7% in FY2016 and 16.4% in FY2017, according to a Kotak report. This is much higher than the 5.7% expected in FY2015. Real estate is expected to lead the Nifty companies with a 43.4% growth in FY16, followed by auto (33%), cement (28.4%) and industrials (32.7%).
