Indian markets have continued its strong bull run. Since, the start of 2021, the Nifty 50 Index has gained a massive 27 percent. In comparison, the MSCI Emerging Market Index has remained almost at the same level.
India has topped up other major markets as well. During the same period, S&P 500 has gained 17 percent., Dow Jones has gained 12 percent., NASDAQ has gained 16 percent., DAX has gained 13 percent., CAC 40 has gained 20 percent. and FTSE 100 has gained 10 percent.. Recently, India also surpassed the French stock market to become the sixth largest stock market in the world.
The continuing economic recovery of India, in spite of a severe second wave of COVID-19, has been a major factor in creating positive sentiments.
Both the Government of India and Reserve Bank of India has taken several policy actions to support the economy, including the economic package amounting to 13 percent of GDP, production linked incentive schemes and expansion of physical infrastructure.
The economy looks set to recover with nearly 10 percent. GDP growth in FY-22. On top of this, most of the Indian corporates have posted better than expected results and positive commentary, the worry on the third wave of COVID-19 appears to be subsiding and the vaccination drive has picked significant pace.
The domestic front appears quite sorted for now and it has resulted in massive investor confidence. The continuation of bull run is supported by buyers coming in at every dip to push up the indices towards newer highs.
Market sentiments positive, but risks increase significantly
While the sentiments are still quite positive, at the current market levels, the risk have significantly increased. The first factor is that the P/E ratio of Nifty 50 index has climbed to 27x, giving very little room for multiple expansion, unless earnings catch up significantly. In fact, if the earning momentum tapers there is a high risk of multiple contraction, which may put negative pressure on stock prices.
While the economic recovery suggests that the topline of Ccompanies is likely to grow, it doesn’t guarantee a commensurate increase in net profits, since input side costs have been going up due to global supply-demand constrain.
The global economy is staring at an inflationary environment, which is expected to further increase the input costs for Companies.
On top of this, there are two very significant event risks that the global market is staring at. The labour market constraints may lead to medium term high inflationary environment leading to interest rate moving up in medium term. Additionally, there is a huge event risk due to the unfolding debt crisis associated with the real estate sector in China, that may lead to selling pressure across the board.
The level of contagion effect can’t be estimated with any certainty due to lack of significant data availability. The volatility is expected to increase and therefore investors may require a stronger stomach to remain invested.
One other widely known reason for the buoyancy in the equity market is high availability of liquidity. It’s not permanent and very soon US Fed will start tapering.
The Fed has indicated inclination towards raising interest rates next year and a possible start of tapering as early as November of this year. The emerging markets are expected to be impacted more when liquidity dries up, and this will also need to be closely monitored.
Overall, at the current level of Indian markets, we will take a cautious approach and wait for a clearer picture to emerge. If I take an analogy from cricket, the conditions are overcast, there is a nip in the air and the ball is expected to swing quite a bit.
(Mohit Ralhan, Managing Partner & Chief Investment Officer of TIW Private Equity)
