No country for bears

Calls for a correction have been ignored in this market

Two months ago, on this blog, I wrote that it was time for a break, a pause of sorts for the stock markets in India. Clearly, I was wrong. As the rally of the past few days has shown, markets are hungry for more. To put this in perspective, on July 7th, when I wrote that post, the Nifty closed at 8,338, up a whopping 22% from its Budget 2016 low of 6,826 on 29th Feb 2016. 

However, as I write this, the Nifty closed at a new 52-week high of 8,969 today (September 7th) – or a 7% rise in two months. Thus, since 29th Feb 2016, the Nifty is up by a whopping 31%. By any counts, the 7% rise in the past two months is a significant move and one that I got completely wrong. Let’s take a look at the main reasons behind this rally in the markets:

Reason 1: Surge of liquidity to emerging markets 

Since the global financial crisis, central banks have been at the forefront of global liquidity. Unconventional policies such as quantitative easing, bond purchases, low to negative interest rates, have resulted in a surge of liquidity globally, as investors chased high-yielding assets such as emerging markets (EM) equities and bonds. 2016 has been the year of EMs; after seven consecutive months of outflows till Jan 2016, as per the International Institute of Finance, flows surged into EMs from March (record $37bn) all the way to August ($25bn). India, along with other EMs, has benefited from these inflows. The MSCI Emerging Markets is up 16% year-to-date (YTD), compared to which India, up 13% YTD appears a laggard. In early July it was difficult to predict that July and August would also be strong months for EM flows. 

Reason 2: Mild recovery in the Indian economy

The Indian economy has been sputtering along with mixed news: consumer demand is resilient, while industrial demand is weak. Headline GDP growth rates are comfortably above 7% and should remain that way for the rest of this financial year. India’s current account deficit is in control and while inflation has risen, a healthy monsoon should help bring them down. Crude prices are also within the comfort zone of US$60/barrel. The passage of the Goods and Services Tax (GST) in August 2016 was a relief for the markets which had built up this expectation for quite a while, and the Nifty remained range bound for three weeks after the GST passage. On the liquidity front, it is interesting to note that domestic mutual funds have been seeing regular inflows of around Rs 3,000 cr per month from the Systematic Investment Plan (SIP) route.  However, all of these reasons – except the GST Bill – were valid in July as well. Thus, it is safe to assume that sentiment on the domestic front has been stronger than usual. This thesis is believable considering that markets have taken a lot of bad news (the Mauritius tax treaty in June, Raghuram Rajan’s exit in July) in their stride. 

While all of this explains why the Nifty is nearing 9,000 instead of 7,000, the key question is what next? This columnist maintains his bearishness. Here’s why: a) Valuations are too expensive: At 25x earnings (data as per NSE), the Nifty P/E is way above its historical average, and factors in a big turnaround in earnings in the future. Based on past trends, at these elevated P/E levels, the probability of making significant returns in the short-term appear unlikely, b) A US rate hike is around the corner: A hike in interest rates is due in the US, this year. Higher interest rates in the US could reverse the flows to EMs, as the dollar gains strength. So far, liquidity has been sloshing around because interest rates, and the perceived cost of equity, has been falling. A reversal in this trend could bring emerging markets rallies to a halt. 

All things considered, a new Nifty high is likely around the corner. It is a good time to take a realistic view of what lies ahead and assess risk versus return. While I would gladly be proven wrong if the Nifty crosses 10K by Diwali, I maintain my reasons to be cautious today, as I was in July.

Anupam Gupta is a Chartered Accountant and has worked in equity research since 2000, first as an analyst and now as a consultant. He contributes to the Business Standard platform, Punditry, through his blog, Beyond Markets on markets & the economic horizons. 

He tweets as @b50