Waiting for action

The Indian market looks like it has run out of steam

The stock market has had an eventful few days - weeks, in fact. Many believe that the uptrend that had been seen since early 2014, of relentless bullish optimism, may be on the brink of ending. Indeed, some think that bearishness has already set in. The numbers are interesting; on Monday, for the first time since September 2013, the two benchmark stock indices closed below their 200-day moving averages. Many stocks are at 52-week lows, and there have been several days of losses. Even top-of-the-line stocks, such as HDFC and Unilever, have seen selling.

The forces behind this movement are relatively easy to pin down. First of all, it is clear that foreign money has fallen out of love with India. Confused and angered by their treatment at the hands of the taxman as well as by the lack of clarity on the pace of reforms, foreign institutional investors or FIIs are looking at other options. The trend is particularly clear to see in debt, where FIIs are expected to turn net sellers of Indian debt in April, for the first time since India began to shrug off the taper tantrum in late 2013. A certain overconfidence had crept in about India's chances - after all, where else could global capital seek returns? Europe was still struggling, US equities were supposedly overbought, and all other emerging markets were in trouble or in the doldrums. However, a strong winning streak since January 1 in the Chinese markets shows that this is not a sustainable belief. And among the major world markets, Indian stock market indices have slipped the most from their highs in 2015.

The second point is that optimism has essentially been priced in - heavily. The market now is action-oriented. It will respond to clear and present action that will improve further earnings. If signs come in that earnings recoveries will be further delayed - as seems to be the case following the early bird results - then, naturally, it will lose value. If the government takes sustainable reform action, then the markets will respond appropriately.

The impact of the FIIs' inflows on the markets has been odd. It has, in effect, created a dual market. The Sensex has a price-earnings (PE) ratio of 18.7, down from 19.3 on January 1. Indeed, the biggest 500 companies - as measured by the BSE S&P 500 - are at a PE of 20.6 now, marginally up from January - and from 17.2, 16.5, and 14.6, their values one, two and three years ago respectively. This does not seem remarkable. However mid-cap and small-cap companies are more expensive - at PEs of 27.9 and 25.3 respectively. The carnage in small-cap companies in the past months and weeks has been intense - the PE for small-cap companies stood above 60 on January 1 this year, and was above 40 a year ago. The suggestion is clear: prestigious companies with clear balance sheets, the sort FIIs like, are holding their value, but the general trend elsewhere has been downward. Some sectors and companies are very expensive indeed. FMCG is at a PE of 48.5 and capital goods at 53.3 - but realty is at 15.4, and banks, dragged down by the public sector, at 16.8. The variation within such sectors between companies that FIIs will buy and those they won't starkly diverges from fundamentals. HDFC Bank is at 23.6, while State Bank of India is at 12.4.

Clearly, the markets have had a comfortable run thanks to FII money, and that trend might well reverse. Whether or not that means that India is at the beginning of a bear trend depends - it depends on how bad corporate earnings are, how the United States Federal Reserve views its monetary stance, and whether or not the government is willing to take the sort of reform measures that will please an action-oriented market.