A festive spirit has enveloped the stock market this year too with both the benchmark indices racing to record highs in the pre-Diwali rally. Investors in Indian stocks have made decent returns over the past year, with the Sensex and the Nifty gaining nearly 15 per cent; stocks in some sectors such as consumer durables, metals and realty have given far higher returns. However, the return expectation from Samvat 2074 needs to be scaled down significantly. This is due to the fact that the rally in stock prices over the last year was driven primarily by liquidity from foreign as well as domestic investors. A weakening dollar has made foreign investors pour money into stock markets in emerging Asia, including India. Domestic investors, in the absence of a lucrative investment option given falling interest rates and a weak real estate and bullion market, have been pumping money into stocks through mutual funds. But with global central banks, including the Fed, moving towards monetary tightening, foreign investment flows might not be this robust in the coming Samvat. This can impact domestic flows.

Of greater concern is the weak performance of listed companies in recent quarters. While there was a recovery in earnings growth in the first three quarters of FY17, corporate performance has been sliding downhill ever since. Earnings growth of companies constituting the Nifty declined almost 10 per cent in the June quarter compared to the corresponding quarter last year. The hit was partially due to the halt in production and de-stocking by retailers prior to the launch of GST; the transition to the new tax regime is expected to hit earnings in the September quarter, too. Most analysts have, however, pencilled in 12-14 per cent growth in Nifty earnings for FY18. Unless earnings grow in high teens in the last two quarters of this fiscal, stock prices will have to move lower to match the muted financial performance. Meanwhile, the rally in stock prices has taken valuation of the benchmarks far above their long-term averages, drawing close to the PE multiple witnessed towards the end of 2007. While the peak valuation in 2007 could be justified due to strong earnings growth then, that argument does not work now.

A fast-paced economy was another argument put forward by the optimists in 2007 to justify surging stock prices. But the economy is currently sputtering, with growth hitting the lowest level in the last three years. The Centre’s crackdown on black money, along with the implementation of GST, has impacted businesses in the informal sector. While the long-term benefits of these moves cannot be denied, the short-term impact will be to curtail demand, making companies postpone their plans to add capacity. With private investments not likely to pick up over the coming quarters, it is up to public expenditure to stoke a recovery. Given these myriad issues, investors need to brace themselves for a muted stock market performance over the next year.

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