More pain in store? Reality check for stock markets after a dream run

After a relentless run, stocks are set for a reality check as investors evaluate how much the markets can be devoid of economic fundamentals.

On Friday, equities posted their biggest weekly drop since May, with the benchmark Sensex and Nifty dropping nearly 3 per cent amid a sharp sell-off in technology stocks in the US. Both foreign as well as domestic investors were seen pulling back their investments amid doubts over the pace of economic recovery. The selling came in the week when the data showed India’s gross domestic product had contracted 23.9 per cent in the June quarter — the worst among Group of Twenty nations.

Is more pain in store for investors? Experts don’t rule out further weakness. However, they rule out a big crash, given the favourable liquidity conditions globally.

“The rally may not fizzle out, but in the near term, there can be some profit-taking. India has outperformed most emerging markets (EMs). Hence, a small correction is warranted and should be viewed as a healthy sign since rotation is always good for long-term strength in the market,” said Amit Shah, head of India equity research, BNP Paribas.

The Sensex on Friday ended at 38,357, while the Nifty closed at 11,334. BNP believes the maximum downside from the current levels will be less than 10 per cent for the benchmark indices.

From the March lows, the Nifty has rocketed 49 per cent in rupee terms and 55 per cent in US dollar terms. The best gains for any EM after South Korea. Going ahead, some believe the domestic markets could lag global peers due to a sharper hit to the economy owing to strict lockdowns imposed to contain the spread of coronavirus.

Andrew Holland, chief executive officer, Avendus Capital Alternate Strategies, said the macro pressures on the economy were well known, but the markets have shown little concern. “The government has to spend more money and act fast to revive growth. If there is a vaccine before November, the economy recovery path for 2021 will look certain,” said Holland.

Experts said the bull-case scenario for the market is the global liquidity support will continue and economic recovery will be sharper than anticipated. Experts see some green shoots in the form of above-average monsoon, improvement in rural income, and tax collection.

What could pull the markets down is global volatility as seen last week, uncertainty around the US elections, and large investors deciding to take money off the table. Rising Covid-19 infections could weigh on the markets as they could mar the economic recovery process. “The GST is the best indicator of economic activity, and the numbers suggest the economy is well on the path to recovery. But the continuing rise in Covid cases is a cause for concern,” said U R Bhat, director, Dalton Capital Advisors (India).

Shah of BNP believes global liquidity is one of the comforting factors for the market. “We do not see a sharp downfall from the current levels, especially after the Jackson Hole annou­ncement by the US Federal Reserve that it is moving to an average long-term inflation of 2 per cent,” he said.

The rally and earnings deterioration have seen market valuations rise to record levels on a 12-month forward basis. However, markets players say investors are looking at sharp improvement in corporate earnings in FY22 and are ignoring the current price-to-earnings (P/E) multiples.

“The markets are looking at FY22, wherein, assuming normalcy returns to the economy and corporate profitability, P/E ratios seem to be at a more reasonable 17x,” said Mayank Khemka, chief investment officer-India, Deutsche Bank Wealth.