Is the Indian Stock Market in a Bubble?
The Indian stock market has been on a historic bull run, with the Sensex and Nifty 50 breaking records and crossing milestones never seen before. On July 3, 2024, the Sensex, a benchmark of 30 major companies listed on the Bombay Stock Exchange (BSE), crossed 80,000 points for the first time, after rapidly climbing from 70,000 in just 80 trading days and then from 75,000 to 80,000 in only 58 days. Similarly, the Nifty 50, comprising 50 of the largest companies in the National Stock Exchange (NSE), has also reached unprecedented highs.
The market’s extraordinary performance has led many to ask a fundamental question: Is the Indian stock market overvalued? Are we seeing the early signs of a bubble? Experts are divided on this issue. While some believe that the market’s growth reflects global confidence in India’s economic future, others warn that the current valuations are unsustainable, with certain companies exhibiting dangerously high price-to-earnings (PE) ratios.
In this blog, we will explore the reasons behind the current bull run, assess the risks of an overvalued market, and examine the role of individual retail investors in shaping the landscape of Indian equities. Additionally, we will look at how the government's policies, technological advancements, and foreign investment have contributed to this boom. Finally, we will assess whether the market is likely to face a correction or even a crash in the near future
The Unprecedented Growth of India's Stock Market
A Surge in Retail Investors
One of the key factors behind India’s stock market rally is the surge in retail investors, particularly since the COVID-19 pandemic. Data from the National Stock Exchange (NSE) shows a sharp increase in the number of registered investors, growing from just 1 crore (10 million) in July 2010 to 9 crore (90 million) by April 2024. This rapid growth has shifted the power dynamics in the stock market, with individual investors and mutual funds now holding more sway than foreign institutional investors (FIIs) for the first time in decades.
A significant portion of these retail investors are young, with 40% under the age of 30. Many come from Tier 2 and Tier 3 cities, driven by the accessibility of new stock brokerage platforms like Zerodha, Groww, and Upstox. These apps have democratized investing, enabling millions from non-metro cities to participate in the market, an opportunity that was previously reserved for those in major financial hubs like Mumbai and Delhi.
The table below illustrates the growth of registered investors on the NSE over the past decade:
This surge in retail participation has driven stock prices upward, as new investors buy into stocks, often with little regard for traditional valuation metrics like the PE ratio.
The Impact of Stock Brokerage Apps
The rise of easy-to-use stock brokerage apps has played a pivotal role in bringing first-time investors into the market. Zerodha, Angel One, Groww, and Upstox have capitalized on India’s growing internet penetration and smartphone usage, making investing as simple as a few taps on a mobile screen. As a result, younger, tech-savvy investors from smaller towns and cities have entered the market in droves, pushing the prices of stocks higher. According to reports, in 2023, 80% of Upstox's customers came from non-metro cities, highlighting the democratization of stock market access.
Why is the Market So High?
Foreign Investment and Global Confidence
Apart from retail investors, foreign institutional investors (FIIs) have also been highly optimistic about India’s market. In just two months, FIIs have invested $5 billion into Indian stocks, reflecting global confidence in India’s economic potential. Moreover, India’s weight in the MSCI Emerging Markets Index has increased from 8% in 2020 to 18% in 2024, signaling growing interest from global investors.
This foreign interest is driven by India's improving economic fundamentals, demographic dividend, and the government's focus on sectors like infrastructure, defense, and renewable energy. The chart below provides a snapshot of foreign investment in the Indian stock market over the past five years:
Government Policies Encouraging Market Investment
Several government policies have also contributed to the stock market’s unprecedented growth. In 2015, the government amended rules to allow pension funds, including the National Pension System (NPS), to invest in equities. This has led to a steady inflow of retirement money into the stock market, further fueling the bull run. Additionally, India’s focus on creating investment-friendly sectors, such as renewable energy, defense, and infrastructure, has attracted long-term capital.
Is the Market Overvalued?
Price-to-Earnings (PE) Ratio Analysis
One of the most commonly used metrics to assess whether a stock or the broader market is overvalued is the PE ratio, which compares a company’s stock price to its earnings per share (EPS). A higher PE ratio indicates that investors are paying more for each unit of income, which can be a sign of overvaluation.
According to a recent report by Kotak Institutional Equities, over 104 Indian companies have PE ratios higher than 50. In fact, nine of these companies have PE ratios exceeding 100, meaning investors are paying 100 times what the company earns per share. For context, a PE ratio above 30 is generally considered expensive, while anything above 50 is typically seen as unsustainable in the long run.
Consider Zomato, for instance. Despite its relatively modest earnings, the food delivery giant's PE ratio is over 500, fueled by investor excitement following the company’s first-ever profit announcement. This has sparked concerns that investors are blindly piling into stocks without considering long-term fundamentals.
The Warren Buffett Indicator Another widely followed indicator for market valuation is the Warren Buffett Indicator, which compares the total market capitalization of all listed companies to a country’s GDP. Historically, this ratio for India has averaged around 0.91. As of 2024, the indicator stands at 1.02, suggesting that the Indian stock market is overvalued relative to the size of the economy.
The table below shows how the Warren Buffett Indicator has evolved for India over the past decade:
Risks Facing the Stock Market
Small-Cap Stock Volatility
While large-cap companies like Reliance, Tata, and Infosys dominate headlines, small-cap stocks have experienced a more volatile journey. Small-cap stocks are companies with market capitalizations of less than ₹5,000 crore. While they offer the potential for high returns, they are also notoriously risky.
SEBI, India’s market regulator, issued a warning in March 2024, urging investors to exercise caution when investing in small-cap stocks. Historically, small caps have been more vulnerable to market downturns. For instance, during the 2008 global financial crisis, the small-cap index fell by 78% and took nearly eight years to recover. While some investors have made substantial gains in small caps, others have suffered significant losses due to the volatility.
High PE Ratios in Traditional Sectors
What makes the current market bubble particularly concerning is that even companies in traditional sectors, such as automobile manufacturers, are displaying unusually high PE ratios. Kotak’s report highlights that companies producing petrol and diesel-powered vehicles, which are unlikely to thrive in a future dominated by electric vehicles, still have inflated valuations. This irrational exuberance is reminiscent of past bubbles, such as the dot-com boom in the early 2000s, where companies with little revenue were valued at astronomical levels.
Fear of a Potential Market Correction or Crash
While a market correction—a short-term decline of 10-20%—is a normal part of market cycles, some experts fear that the Indian stock market may be headed for a more severe crash. Christopher Wood, the global head of equity strategy at Jefferies, believes that the Union Budget could trigger such a correction, especially if new capital gains taxes are introduced. The government has been considering raising the long-term capital gains (LTCG) tax, currently set at 10%, to reduce speculative trading and encourage long-term investment.
A crash, on the other hand, refers to a sudden and severe drop in stock prices, often driven by panic selling and systemic economic issues. While no one can predict whether a crash will happen, many investors are keeping a close eye on macroeconomic indicators and company earnings to gauge whether a correction is on the horizon.
Conclusion: Is the Stock Market in a Bubble?
The Indian stock market's performance over the past few years has been extraordinary, driven by a combination of retail investor participation, foreign investment, government policies, and technological advancements in stock trading platforms. However, with PE ratios at unsustainable levels for many companies and the Warren Buffett Indicator flashing warning signs, there are legitimate concerns that the market may be overvalued.
While large-cap stocks may weather a correction, retail investors, particularly those invested in small-cap stocks, could face significant losses if retail investors continue investing heavily in small-cap stocks, they may be more vulnerable to significant losses during a market correction. Small-cap stocks tend to be more volatile and less stable than large-cap stocks, which often have the resources and resilience to endure downturns better. Retail investors should consider balancing their portfolios with more stable assets and avoid overexposure to risky investments to protect against sudden market shifts.