Beware the equity market bubble: Experts raise the red flag

The RBI in its recent annual report warned of a possible equity market bubble, subtly cautioning investors against irrational exuberance.

Published: 16th June 2021 07:55 AM  |   Last Updated: 16th June 2021 08:23 AM   |  A+A-

Nifty, Sensex, BSE, NSE

For representational purpose. (Photo | PTI)

Express News Service

NEW DELHI: The Indian equity markets seem to be going through a purple patch. Even as the COVID-19 pandemic wrecked the backbone of the economy in 2020 and 2021, the markets don't seem to mind a bit.

In the past year, the BSE 30 Index Sensex has sprung from 33,228 to 52,773 points, gaining 59 per cent on the way. Since 23 March 2020, when the lockdown was first announced, the equity markets have returned almost 100 per cent . The Sensex during the period rose from 27,600 points to 52,773, gaining 91 per cent.

The 'bull run' continues even if regulators and a few market experts have already raised the red flag. The RBI in its recent annual report warned of a possible equity market bubble, subtly cautioning investors against irrational exuberance.

RBI’s concerns are not without reasons. Valuations have gone through the roof, and yet the markets have climbed new peaks driven by easy liquidity provided across the globe by governments to support growth to pandemic-hit economies. 

India’s current market cap to GDP ratio is 112 per cent , against the historic average market cap to GDP ratio 76 per cent . The Sensex is currently trading at a price-to-earnings ratio of 32 against the five-year average of 21. However, experts are not impressed by such high valuations.

According to Geojit Financial Services' chief investment strategist VK Vijayakumar, robust foreign institutional buying, select high-quality buying by domestic institutions and enthusiastic retail activity are positives for the market, but the froth building up in the broader market is a big worry. 

Vijayakumar points out that the Nifty small-cap index trading at a premium to Nifty reflects the 'irrational exuberance' of retail investors.

In 2020-21, foreign institutional investors (FIIs) pumped in Rs 2.74 lakh crore into the Indian equity markets, the highest ever in a financial year. This was mainly on account of liquidity infused in the system by countries across the globe to support their respective economies.

Retail investors also participated in the bull run with over Rs 4 lakh crore being funnelled into equities through mutual funds alone.

Deepak Jasani, head of retail research, HDFC Securities, says: "A lot of companies have seen an expansion in their P/E ratios, anticipating a rise in their earnings. In many cases, the PEs seem to be all-time highs. However, in case of a sharp sell-off in the markets, a lot of these stocks could also bear the brunt and see a derating of their P/Es."

Some experts believe the distress caused by COVID-19 may catch up with the market sooner or later. Ajay Shah, an economist and a former professor at National Institute of Public Finance and Policy, says the difficulties of middle class are likely to impact the market with a lag.

Experts are expecting a 10-15 per cent correction in the near term as the valuations are getting a little stretched. Given this situation, how should retail investors wade in the market? Kotak Mutual Fund CEO Nilesh Shah says that this is the market where one needs to invest with long-term view and not short-term view, while advising against going overweight on equities.

Hemang Jani, head of equity strategy, broking & distribution, Motilal Oswal Financial Services, however, cautions retail investors against booking profit and sitting on cash because "it may turn out that one may miss the bigger rally while awaiting for the correction to take place".

Stick to investment fundamentals

Experts also say that no matter how the equity markets are behaving, retail investors should stick to basic tenets of investments diversification, asset allocation, rebalancing of portfolios. A sharp correction, experts say, is 'normal' in equity investing.


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