Investors To Stay Cautious Amid Dream Run

Bombay Stock Exchange. (File Photo: IANS) by .
Bombay Stock Exchange (File Photo: IANS)

The Indian stock markets seem to be on a steroid-infused dream run. Both the National Stock Exchange’s Nifty-50 and the Bombay Stock Exchange’s Sensex have surged to record highs almost every day in the last few weeks. The former crossed the 10,000-mark for the first time since its inception two decades ago while the latter breached the 32,000 mark, a lifetime high in itself…. A special report by Amit Kapoor for Asian Lite News

Bombay Stock Exchange. (File Photo: IANS) by .
Bombay Stock Exchange (File Photo: IANS)

Both of these indices, which represent 50 and 30 of India’s largest companies, respectively, are generally seen as the referential guide on the country’s business sentiment and economic activity. However, this does not seem to hold true in the current economic scenario.

The stock market is performing exceedingly well despite low investment activity across the country. The problem of rising non-performing assets in banks has been highly inimical to corporate lending and, thus, private investment. The lending situation has worsened to the extent that bank credit increased by merely 5.1 per cent in the fiscal ending March 2017, which has been the lowest since 1951. Likewise, fresh corporate investments during the same period have grown at their slowest pace since 1992. Just going by these factors, it can be said that business sentiment across the country has been at its worst in decades. Therefore, the recent stock market performance seems inexplicable.

The bull run of the stock market is, however, being driven by a few domestic and international factors that are unrelated to real investments. First, as noted in my column last week, Indian households have been displaying a non-linear shift towards savings in financial assets post-demonetisation. Mutual funds have emerged as the preferred mode of investment. In fact, net inflows into mutual funds have witnessed an expansion of 155 percent, which is the highest in their history in India. These funds ultimately find their way into the stock markets. Retail investors and high net-worth individuals are also choosing to put their money in financial assets rather than holding cash.

Mumbai: A view of Bombay Stock Exchange (BSE) and National Stock Exchange (NSE). (File Photo: IANS) by .
A view of Bombay Stock Exchange (BSE) and National Stock Exchange (NSE) (File Photo: IANS)

Second, the market performance can also be seen as a positive response to the Goods and Services Tax (GST) that was implemented from July 1. The GST has not impacted corporate earnings for the organised sector as they were paying taxes earlier anyway and the tax slabs have ensured that the tax rate would not vary much from their earlier levels. Moreover, the implementation of GST has unified the Indian states into a common market, making it easier to transport goods across state borders and to do business in general.

Third, on the external front, global investors have regained their faith in the Indian growth story. Foreign direct investment hit an all-time high of $60.1 billion in the last financial year. On the other hand, foreign portfolio investors (FPIs) have also recently become bullish on the Indian market. Net FPI inflow, which had been Rs 48,411 crore (more than $7.5 billion) in 2016-17, has already exceeded Rs 1 lakh crore ($15 billion) in the current financial year from April 1.

The faith imposed by foreign investors in the Indian economy has been due to its strong fundamentals and future growth prospects. Inflation has been consistently falling from a high of 12 per cent in 2013 to as low as 2.18 per cent in May 2017. The fiscal deficit has also narrowed to 3.5 per cent of the GDP in 2016-17 from a high of 6.6 per cent in 2009-10. The current account deficit has also been contained at 0.6 per cent. This puts the country’s balance sheet in a comfortable zone. With a stable rupee and low oil prices, the situation cannot destabilise any time soon. All these factors have made India an attractive foreign destination compared to other emerging economies.

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President Pranab Mukherjee and the Prime Minister Narendra Modi pressing the buzzer to launch the Goods & Service Tax (GST) in Central Hall of Parliament in New Delhi

Nevertheless, the markets are, in fact, overvalued, with the Nifty trading at a price to earnings (PE) ratio of 25.5 when the long-term average is between 17 and 19. The highest PE ratio that the Nifty has ever achieved was 28.5 in February 2000 during the dotcom bubble after which it went into a free fall for the rest of the year, along with the stock markets. Generally, a Nifty PE above 22 is considered overbought. The stocks will maintain their upward trend in the short run as the RBI will expectedly reduce rates this week. A good monsoon will further boost investor sentiment.

However, as only domestic and global liquidity is driving markets and not real investment, stock prices will keep running ahead of their fundamentals. Valuations will get expensive and when earnings will not see commensurate growth, markets will consolidate at a lower level. Therefore, a correction is expected any time soon. That could happen with any trigger on the global or domestic front, ranging from an escalation of the Doklam standoff to an abrupt withdrawal of FPI funds.

Hopefully, before such a situation arises, investment activity will pick up as the NPA issue is gradually resolved and earnings will grow to support the market performance and reduce its fragility. Until then, going forward, investors need to remain cautious on stocks and avoid being driven by animal spirits.