Analysts divided over lower volatility outlook

India VIX, essentially a fear gauge, closed the day at 11.74 falling from 15.83 at beginning of 2017

On Wednesday, the BSE Sensex soared past the 30,000 level, ending the day at an all-time high of 30,133. And, this rally has been accompanied by near-record low volatility.

India VIX, essentially a fear gauge, closed the day at 11.74, falling from 15.83 at the beginning of the year. The index is a measure of how much volatility investors expect. A low value indicates an optimistic outlook.

What explains this and will it sustain? Analysts are divided. While some suggest the positive sentiment will keep volatility subdued, others are not so sure.

“The low volatility is because the sentiment is extremely positive. Markets have factored in the major tax reform (goods and services tax) undertaken by the government and the gains that will flow from this. This is attracting capital flows,” says Sahaj Agrawal at Kotak Securities. “There is also stability. The NPA (non-performing assets) issue is also being openly discussed. Solutions are being talked about.”

Another analyst concurs. “India VIX has done well, compared to the global VIX. I see it languishing around the current levels. This rally has been broad-based, led by banks, automobiles and capital goods. Only defensive sectors like information technology and pharmaceuticals haven’t really participated and we continue to see them underperform,” says Gautam Shah, chief technical analyst at JM Financial.

While other markets (Mexico, Taiwan, Korea) have also received strong flow, India has emerged as one of the fastest growing large economies. Four years after being clubbed in the 'fragile five' category among merging markets, a period of macro economic stability has brought gains.

This and a perception of political stability after the election results in Uttar Pradesh have added to the positive sentiment, say analysts. This has lowered the risk and is a key reason for the positive sentiment and increased buying among foreign investors. Since January, foreign institutional investors have pumped Rs 42,886 crore in equities. Over the past year, the Nifty 50 benchmark on the National Stock Exchange has risen 17.5 per cent, as opposed to the MSCI emerging market and world indices, which returned 16.6 per cent and 11.65 per cent, respectively.

Another reason for the low volatility is that apart from unpredictable geopolitical issues, analysts believe the uncertainty is low. “Most global issues are out of the way. (The expectation of) A normal monsoon is also factored in. Expectations are that earnings can only pick up from here. India is in a sweet spot,” says Shah. This has lowered the risk profile.

Some analysts differ. “It’s essentially Reliance (Industries) that is driving the current rally. Other index stocks aren’t really moving. Unless there is a secular bull run across all counters, you will see the VIX at the current levels,” says Deven Choksey, managing director of broekrs KR Choksey. “The dominance of exchange traded funds has increased and their trading pattern has in fact kept the market in check.”

On concerns over valuations, while one could argue that earnings growth might not match up to expectations, analysts believe the valuations aren’t stretched. “The one-year forward earnings multiple is around 17. Above 18, you could consider it as being stretched. But, historically, we have tested 20. So on that basis alone, there appears room on the upside,” says Agrawal.