A couple of decades ago, R K Laxman's choice of subjects used to be an excellent indicator of investor sentiment. The great man was disinterested in the stock market and rarely alluded to its gyrations in his daily "pocket" cartoons. When he did feature the market, his cartoons coincided with a major market peak or bottom and usually came within a few sessions of big trend reversals.
I puzzled over this, looking at newspaper archives of the 1980s and early 1990s and evolved an hypothesis. Stock markets make a lot of "noise" at peaks and troughs. When the decibel level is high enough to attract the attention of a disinterested party such as RKL, the market is overbought or oversold, with sentiment ripe for reversal.
Sadly, Laxman is no longer active. The explosion of financial media also means there is too much information floating around and somebody is always talking loudly about the market. What is more, the sentiments of key market players are moulded by events happening far away. (Click for chart)
So, there is an unusual divorce of local sentiment from equity movements. Indian stock markets are trading at near all-time peaks. It is Diwali - the festive season when excessive consumption is practically considered to be a religious duty. Yet, there is no wealth effect evident, and sentiment seems anything but upbeat.
Very few Indians have made serious capital gains in the last year. The numbers are straightforward. In the last 12 months, the Sensex and Nifty have risen about 17 per cent in rupee terms. During that period, the foreign institutional investors (FIIs) have invested over Rs 117,000 crore and domestic institutional investors have sold over Rs 62,000 crore. The excess of FII buying over domestic institutional investor selling tells us that domestic retail investors have also been net sellers. This is confirmed by data that indicate households have been net redeemers in mutual funds.
Macroeconomic data and broad corporate trends also suggest downbeat sentiment. Both the services purchasing managers' index (PMI) and the manufacturing PMI have contracted, reflecting weak trends across 85 per cent of the economy. The Index of Industrial Production also suggests very weak recovery.
Consensus gross domestic product (GDP) projections for the second half of 2013-14 have settled into the 4.25 to 4.75 per cent range. In dollar terms, Indian GDP contracted in the first five months, to $1.826 trillion between April-August 2013 versus $1.84 trillion in April-August 2012.
Relatively few companies have seen earnings upgrades so far, in the wake of first half results. Whatever acceleration has occurred can be attributed to a weaker rupee. The information technology sector has done well and so have select automobile and auto-ancillary shares, and jewellery exporters. Pharma, which was expected to do well, has been hit by the US Food & Drug Administration's tightening standards. Textile exports, too, don't seem to have stepped up as much as hoped-for.
Cement, infrastructure development, power, construction, metals, etc, have all taken a hammering. Banks and non-banking finance companies are struggling to manage lower growth and sticky loans continue to rise, albeit at reduced pace. Among domestic sectors that don't have strong currency correlation, assorted agro-related businesses such as Escorts, United Phosphorus and Rallis have done well. This is anecdotal evidence that agriculture is indeed growing.
Inflation continues to be a bugbear. If Indian GDP is deflated using consumer prices, the economy is shown to be in recession for the past three years. Statistical jugglery aside, this is a good explanation for the absence of euphoria normally associated with high equity prices. This lack of optimism is also why Diwali is unlikely to provide a major consumption boost to second half GDP.
The Reserve Bank of India has clearly given up on trying to foster growth and decided to focus on its key task of controlling inflation, while ensuring there's adequate liquidity within the banking system. Since it expects inflation to remain high, and growth to be muted, expect another repurchase rate hike soon enough.
Meanwhile, the swap-scheme that offered incentives to banks to bring in overseas deposits seems to have worked well, with over $10 billion coming in. The rupee no longer appears to be in danger. It might depreciate - in fact, it almost certainly will, once the US starts tapering. But the volatility of depreciation is not likely to be high and markets would welcome predictable depreciation since it improves earnings visibility in exporters. Given a smaller trade deficit and a big boost to invisibles (mainly IT services), the current account deficit will shrink considerably in 2013-14.
For traders, the US Fed's take on tapering and perhaps, the outcome of the assembly elections in December, will be the next events to watch. The Fed will not taper till January at the least. Until the Fed tapers, FII flows are likely to remain positive. While FII flows remain positive, the market, or at least the larger more liquid shares in the derivatives segment, are likely to move up. Unexpected Assembly election results may change expectations but we're almost certain to see new index-records set before that.
Right now, the Nifty is trading at current price-earnings (PE) ratio of 18-plus. Consensus earning expectations are in the range of 12-15 per cent for 2013-14. Short-term government treasury yields are in the range of 8.5 per cent. The price-book value (P-BV) ratio is above 3. Whether you compare earnings yield to treasury yield, or use a PE-growth measure, or look at historic P-BV levels, this amounts to serious over-valuation.
It also indicates a strong ongoing trend that is right in line with bullish trends in other major equity markets. Trends tend to overshoot a long way before they reverse. Celebrate Diwali and continue to ride the trend. But be prepared for a steep fall, as and when there is a reversal.
Disclaimer: These are personal views of the writer. They do not necessarily reflect the opinion of www.business-standard.com or the Business Standard newspaper
