If one looks at the movement in stock indices over, say, the end of December, which was before Donald Trump took over as president, the progress has been remarkable across various global markets. The S&P 500 was up 13% as of September 24th, while the Nikkei 225 was up by 14.4%. Shanghai Composite increased by 15%, while FTSE 100 was up by 13.2%. In the Euro area, DAX (Germany) was up by 18.9%. However, the Sensex was up by just 4.6%. It was lower for SMI (Switzerland) at 3.3% and CAC 40 (France) at 6.1%. East Asian markets registered similar, if not higher, increases, with KLSE (Malaysia) being an outlier at -2.6%. Is there some logical explanation here?
The answer prima facie is no. India has shown the highest level of resilience to the external environment, which can be best described as an economy with the highest growth rate among large economies under stable and low inflationary conditions. Forex reserves have built up to over $700 bn, indicating a strong external position. This strong performance has been topped by a rating upgrade by S & P, which should have been a booster. There seems to be little reason for the markets to behave in this manner. True, any positive information has been greeted with a push for the stock indices for a couple of sessions, after which it has been mean reverting. Is there something which we are missing?
In fact, the index did show an upward movement in the period May-July, after which it moved downwards and became volatile. Interestingly, the number of issuances of IPO has been remarkable, with a plethora of companies raising funds. The success rate in terms of listing at a premium has been quite high, reinforcing confidence in the market. Hence, this looks like an anomaly, given that the interest of investors is high. Also, with several retail investors joining the fray through both the IPO and mutual fund routes, the demand for equities should have been high, leading to higher prices of stocks rather than lower.
The reasons could be manifold. First, the performance of companies has been below potential. This can be seen by topline growth remaining in the 4-5% range for most industries. While profits have grown due to cost rationalisation, buoyancy in growth in sales has been limited to specific industries. This can be one major factor responsible for limited traction in the indices. Ultimately, profits need to increase on a continuous basis to justify higher stock prices. Presently, there is a distinct dichotomy in corporate performance where, on the manufacturing side, infra-based sectors are doing well, which is not the case with the consumer-based ones. This also means that their performance in the coming quarters would be tracked closely by the market after all the measures that have been taken by the government.
Second, related to the first reason is the debate on whether most stocks are already overvalued, which has not been commensurate with growth in earnings. With the P-E ratios being above 30, the growth in profits must be higher to support such valuations. This has been the view taken by quite a number of foreign investors, who believe that with high valuations at this point in time, scope for an upside is limited.
Third, India has been the focus of the rather hostile tariff policy of the USA, with one of the highest rates of 50% being imposed. This is a dampener for sure for the markets, as there is uncertainty on what lies ahead. While there were negotiations in progress, the visa fee issue has also affected Indian companies which derive benefits from sending professionals overseas to the USA. What started off with 26% increased to 50% in August, which has now been topped by the new visa fee regulation, which would tend to affect the Indian IT sector in particular. While there is hope that this will change with a deal being struck, it is status quo at the moment.
Fourth, the FPIs have been in a withdrawal mood. Now there has been an increase in the purchase of equities by mutual funds, especially through the SIP route. But the act of FPI withdrawal has sent negative signals to the market, which has caused the downward movement. This is, hence, more of a sentiment factor which drives the market. This may be hard to guess in the future, as these flows have tended to be whimsical.
On the other side, the big bang GST programme should have ignited the stock market, as there is big-time spending expected with the rationalisation of rates. However, the effect was limited to specific stocks for a couple of sessions, after which it was back to normal. Therefore, this has not been a game changer for the market.
The hope today is that with the festival season having begun, there will be better times for the market. Diwali can be the watershed point from whence there can be an improvement. The upcoming results of companies, which should come in towards the end of October till mid-November, should throw light on their performance. This can be a trigger. Alternatively, any deal struck with the USA, which reverses the negative sentiment brought in by the tariff policy, will also help to reverse the fall in the indices.
The RBI has upgraded its forecast for the GDP growth to 6.8%, which should provide some more confidence in the market that conditions are improving gradually. The consumer goods industries should register robust sales, which will add to turnover and, hence, improve financial prospects. This, in turn, should also lead to higher investment. Therefore, the conditions are set for a better H2, which can lift the market spirit and keep the direction of movement upwards.
The author is Chief Economist, Bank of Baroda and author of ‘Corporate Quirks: The Darker Side of the Sun’. Views are personal.
