Liquidity-driven rally

Lack of earnings revival will test investors' faith

The most striking change that has happened in the equity markets in the past decade is the coming of age of individual investors. They have kept faith even as returns have been subdued. The Sensex and Nifty have been making new highs, but the 10-year compounded return at 9 per cent a year has not compensated for equity risk, given that real returns have been 2-3 per cent annually. But that has not bothered foreign and domestic investors, and valuations have only climbed to new highs this year.

While foreign investors have liked the fact that India is among the fastest-growing large economies, the behaviour of domestic retail investors has seen dramatic changes. In the past, retail investors used to enter the market towards the end of the bull run and end up taking the hit. But in recent times, retail investors have kept their mutual fund investments going through systematic investment plans (SIPs) of equity mutual funds. Such accounts have gone up from about 6 million in 2014 to 29.4 million now. Investors put in about Rs 8,000 crore in SIPs every month — of the Rs 7.6 trillion equity assets with mutual funds in November, they account for Rs 3.1 trillion. Ten years ago, mutual fund equity assets were under Rs 2 trillion. With most of the money coming in the past five years, mutual fund returns have also been as uninspiring as the broader market. But what investors at the aggregate level have done is to continue their SIPs while reducing their monthly commitment.

The decade began in the aftermath of the global financial crisis and thanks to the quantitative easing in advanced economies, a lot of money found its way into stocks, globally. The US market has been in a bull run with the broad-based S&P 500 index returning about 11 per cent a year — among the best-performing global markets. The India story, however, has sputtered due to a variety of reasons — whether it was the policy paralysis in the United Progressive Alliance government in the first half of the decade or the slowdown that has hit during the National Democratic Alliance government in the second half. In the stock market, there has been a wave of polarisation, both in the US and India, where high-growth companies with a first-mover advantage or quality managements have been valued more than others. While India’s internet companies have shied away from raising funds in the public markets, some financial institutions and consumer companies trade at expensive price-earnings multiples for consistent and predictable growth.

At a broader level, even after a decade of financial crisis, it is still the monetary policies of developed countries that drive flows into equity markets, globally, and would remain an important determinant of foreign investment. However, for domestic investment to keep flowing into the market, the revival of economic growth will be critical. If economic growth and earnings fail to revive over the next few quarters, the patience of retail investors investing through SIPs could be tested. SIP flows have provided stability to Indian stock markets and a reversal could result in significant volatility. In absence of earnings revival, a liquidity-driven rally could further push up valuations and risk.