There appears to be a serious disconnect between the Indian equity market, which has gained 35% in the last 15 months and the mood on the ground. This is quite different from the last equity rally, right after Modi’s Lok Sabha victory in 2014, when the market shot 35% higher in just 12 months. At that time, there was a huge surge of enthusiasm as Modi’s promised acche din were seen as being around the corner. Markets lapped up the rhetoric and took to the skies. FPI surged and nearly $45 billion was added to reserves at an average monthly rate of over $3.5 billion. This time, despite the fact that the global investment environment is much better, reserves have not risen anywhere near as fast; the accretion has been at around $2 billion a month. More to the point, business and macro realities do not reflect the strong showing of the market. Corporate profits are anaemic (other than a few sectors); credit off-take is close to an all-time low; and the cloud of bank NPAs seems immune to all efforts by RBI, which is hardly surprising given the government’s congenital inability to look beyond political expediency. Indeed, the government’s politics-uber-alles approach is coming home to roost with an widening array of angry citizens in the streets.
This disconnect is reinforced by the fact that domestic mutual funds and insurance companies are flush with cash and are buying in parallel with FPIs. The story is that post-demonetisation, a lot of ongoing cash generation has been forced into banking channels, which funds have no place to go but SIP, SIP, SIP. This explains why the market has risen so much with relatively lighter FPI inflows.
Importantly, both of these effects are structurally positive for the market. First of all, if there are more savings in the system, the baseline value of the market will be higher. Secondly, a market is only really healthy when it is driven by both domestic and global savings. Both these bode well for the market in the future. Despite these technical pluses, though, the “spring in the step” is missing on the street.
Could this disconnect merely be the market doing what it does best—i.e., signalling that acche din are, indeed, coming? Indeed, over and above the usual assortment of government shills, there are credible thinkers that believe that we are on the cusp of a sustainable growth spurt. Exports, of all things, have been growing well, reflecting the improved global environment; the monsoon is expected to be good and consumer demand (two-wheelers, for instance) already appears to be picking up.
Of course, the slew of loan waivers will certainly create fiscal pressure, which suggests we may not see any monetary easing any time soon. This begs the reverse view that the market/reality disconnect may be signalling that something is fundamentally off balance.
Corporate results will certainly not be able to support the rich valuations, particularly if the rally continues, which is certainly a possibility. As already mentioned, there is still a lot of cash sitting on the sidelines and the global investment environment also appears hot, again seemingly disconnected from reality. The Dow has risen apace over this period (it is up 31%), the Nikkei has done reasonably well (26%) and the DAX is 38% higher than it was in February last year. To be sure, global business sentiment is relatively better today than it was a year or two ago; nonetheless, equity valuations everywhere look yugely enlarged.
With money to burn everywhere—contemporary art is again hitting records—and volatility near all-time lows, risk once again seems to have turned into a whisper on the global stage, despite the continuing stream of “retail” terrorist attacks, tensions rising in the mid-East, North Korea—quiet this week—and, of course, Master Trump, who can do no
right but can also, apparently, do no wrong.
Of course, the last bears have not yet thrown in the towel. While respected perma-bear, Jeremy Grantham, has turned turtle saying “this time seems very, very different” [www.gmo.com, must read], there are others, like Bill Gross, who fears that risk is the highest it’s been since 2008. Very eloquently, he says that people “instead of buying low and selling high are buying high and crossing their fingers”
But crossed fingers can work as a strategy for a long time. Back in 1996, then-Fed Chairman Greenspan, watching the dot com rally, warned of “irrational exuberance; with or without crossed fingers, the market raged higher for more than three years, rising 75% before ending in tears in 1999/2000.
As always, it promises to be an exciting ride.