Are The Markets Headed For A Bubble?

'The problem is that the bubble may not only be in valuations, but also in investors' minds.'

India's equity markets are currently polarised into small and midcap segments that exhibit bubble-like valuations, and other areas which offer comfortable valuations, chief investment officers of top mutual funds said at Business Standard's BFSI Insight Summit in Mumbai.

They noted that although the markets have retreated from their peaks, earnings growth expectations have also moderated, effectively neutralising the impact on valuations.

"The trouble with the bubble is you will only know when it bursts. Certain segments are good and sensibly priced, but nothing is cheap in the market. The problem is that the bubble may not only be in valuations, but also in investors' minds," said Saileh Raj Bhan, CIO - Equity, Nippon India MF.

"A lot of people are coming in with unreal returns. And if you look at the allocation of money in the last 6 to 9 months in mutual funds, a huge amount of money has gone into sector funds which have done well in the past few years," Bhan said.

When more money chases less amount of equity in the market, there is always a valuation challenge, he added.

"The second question is on the promoter side, promoter selling. The promoters are finding their valuations so expensive that they want to reduce their money, and what they are doing with this money is investing in mutual funds so that they can diversify," said Bhan.

Mahesh Patil, CIO, Aditya Birla Sunlife Mutual Fund, said valuations were elevated in the small and midcap space.

"Largecaps are in a fair zone. We have seen a large rally and a big euphoria in smallcaps and midcaps. A lot of money has gone into that space. So, one needs to be a bit careful because now, with earnings momentum slowing down and lofty valuations, they are likely to be at risk," said Patil.

"We have seen that in this quarter and the last two quarters, whenever companies have disappointed slightly, we have seen a sharp reaction in those stocks, which was not the case earlier," Patil said.

Ashish Gupta, CIO, Axis Mutual Fund, said valuation excesses haven't gone as earnings growth is tepid.

On the impact of US election results on Indian equities, Gupta said the policy direction would be understood only when it gets implemented in the coming months.

"One thing is obvious: You will probably see a higher US fiscal deficit and potentially higher US inflation for a longer period. The market has started estimating this over the last two months, so despite Fed rate cuts, bond yields in the US have risen.

"If this trend continues, if the US continues to remain higher, the prospect of foreign inflows will remain weak for our market," said Gupta.

When asked about the attractiveness of debt mutual funds in the times of equity frenzy, Mahendra Kumar Jajoo, CIO-Fixed Income, Mirae Asset Investment Managers, said there is a reason for optimism as a lot of investors have parked their money in fixed deposits, which do not beat inflation.

"Fixed deposits, since the inception of the banking system, have never beaten inflation. At the same time, debt mutual funds are products which are market-related. The best possibility for any product to beat inflation is when it is a market-related product. Unless you have a diversified portfolio, you cannot become undefeatable," said Jajoo.

Rajeev Radhakrishnan, CIO-Fixed Income of SBI Mutual Fund, said debt funds help investors to beat inflation.

"That is one compelling argument on fixed income today. I am not even talking about any capital gain that may come if interest rates decrease. So, purely from a held-to-maturity investment on a one-year prospective basis, you have visibility of real returns,” said Radhakrishnan.

Regarding the outflows of FPIs and their impact on Indian equities, Gupta said the low FPI investment in the last two years coincided with the rising weight of India in global indices.

"If you look at global emerging market benchmarks, India's weight in the last five years has increased from about 8 per cent to 18 to 19 per cent. Considering that, FPIs are very under-invested in India.

"They will have to come back at some point. But, if I look at the closer term, there is the fact that FII investments are likely to be lacklustre, given what's happened on yield," he said.

Gupta added that domestic investors were able to offset FPI selling because the paper supply was not large.

"So, if I see the pace of the paper supply now, we will need foreign capital inflows to supplement domestic savings and to fund our current account deficit," he said.

Anish Tawakley, Co-CIO - Equity of ICICI Prudential MF, said foreign capital inflows were needed to supplement domestic savings and fund our current account deficit.

"As long as our current account deficit remains in check at about 1% to 2%, we should not spend too much time wondering where foreign flows will come from," Tawakley said.

"As long as our deficit is small and restrained, they will come. And whether they come this month or next doesn't matter."

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Feature Presentation: Rajesh Alva/Rediff.com