Confusing signal

Indices have surged, but broader markets still in loss

India’s financial markets produced a confusing performance in 2018-19. The benchmark big-cap indices produced good returns, but the broader market performance was negative. Foreign portfolio investors (FPIs) were net sellers, while domestic institutions (DIs) bought, on the back of steady retail investments in mutual funds. These dichotomies led to a situation where net market cap grew, but many investors suffered losses. The premier Nifty50 Index was up 14.9 per cent between April 1, 2018, and March 31, 2019. However, only 25 of the 50 stocks in that index registered gains. The mid-cap and small cap indices lost 3 per cent and 11.5 per cent, respectively. The broad NSE500, which covers the 500 largest listed stocks, lost 6.6 per cent. FPIs pulled out Rs 44,500 crore in the financial year but that was more than balanced by domestic buying. One important factor that changed the overall scenario in FY19 was the rising interest rates in global markets. But the scenario seems to be changing for the better, with the US Federal Reserve adopting a softer stance, leading to increased flows into emerging markets like India. The European Central Bank is also expected to delay an interest rate hike.

The rupee lost ground, falling from Rs 64.99 per dollar in early April 2018 to Rs 69.44 by March 30, 2019. The rupee was down below Rs 74 in October. The last two months have seen a surge in FPI buying, coupled with a bounce in the rupee as the Reserve Bank of India has cut interest rates and mounted a swap operation after being placed under a new management. Indeed, the Nifty is up 7 per cent in March, and the rupee has strengthened, as the RBI has become more aggressive in its market operations. 

Valuations remain high for a market that has seen disappointing earnings growth. Given many companies have missed profit estimates over the last four years and several have lowered their outlook for the last quarter, a significant pickup in earnings growth is unlikely. The Nifty is trading at a price-earnings ratio of 27-plus and smaller stocks have even higher valuations. This is despite poor Q3 results and disappointing high-speed data such as slowing automobile sales and low tax collections in the fourth quarter. As investors look to 2019-20 and beyond, they are not simply discounting earnings growth in linear fashion. The elephant in the room is the uncertainty surrounding electoral politics, though the market is betting on a return of the ruling regime. Any surprise in the results could lead to a haze over policy-making, pushing the market to a prolonged uncertain mood. Reason: The BJP is a known factor with a popular leader, whereas the other potential coalitions are unknown quantities in multiple ways. Though most investors will tend to be cautious until the shape of next Parliament is clarified, there is a significant section which cites data over the past three decades to suggest that elections are mere interruptions; the markets will go back to tracking fundamentals and earnings growth, and can deliver strong returns across political regimes. There will certainly be an increase in short-term volatility due to elections, but on a long-term basis, it may be nothing more than noise.