Stock market valuations are substantially greater than the long-run average and not far from the frothy levels of 2007, said the government’s mid-year Economic Survey. The price-earnings (P/E) ratio— a widely watched valuation measure—of the Indian stock market reached a level of 23 in May and is estimated to have touched 25 by mid-July against long-run average of 18.
“It is well known from the finance literature that a key condition for sustaining unusually high P/E levels is for future economic and, especially profit, growth to be rapid, and/or for investors to be willing to accept a lower return for holding stocks over other less risky assets (the so-called equity risk premium),” said the Survey released on Friday. “Failing these, there is a strong tendency for mean reversion all over the world, illustrated for India in the aftermath of the boom of the mid-2000s,” it said.
The Sensex gained 16.9% and the Nifty rose 18.6% in the financial year ending March 31, as against losses in 2015-16. During the year, foreign investors pumped Rs 59,900 crore into Indian equities, while domestic institutions, including insurance companies and mutual funds, net bought shares worth Rs 53,500 crore.
“Historical evidence suggests that there is mean reversion towards more realistic valuations, especially when global excess liquidity is driving high valuation in the first place,” the Survey said.