Laws of gravity work

Stock market indexes can rise and also fall

Since January 2010, there has been a surge in equity values across every emerging market and India has been among the best performers. The Nifty, which tracks the 50 largest Indian stocks in terms of market capitalisation, is up 18.5 per cent since January 2010. At a value of 6,159 points on October 4, it is in touching distance of its all-time highs (6,357 points, January 2008). The Nifty is backed by strong price performance in most key subsidiary and sectoral indices. The CNXIT, which tracks technology stocks, and the Bank Nifty have both hit all-time highs. The Nifty Junior (which tracks stocks 51-100 by market capitalisation) is up 25 per cent since January. Many individual businesses, such as market leaders in metals and automobiles, are also at all-time highs. In the wake of the surging secondary market, the primary market has also seen heightened activity. There have been 53 IPOs since January 2010, raising around Rs 41,500 crore — a massive increment compared to 21 IPOs raising Rs 19,550 crore in calendar 2009. Another 40-odd IPOs, tapping about Rs 54,000 crore, are in the pipeline for the October-December 2010 quarter.

However, though this is clearly a global phenomenon, the extent of institutional polarisation is surprising. Since January, Indian domestic institutional investors (DII) have been net equity sellers to the tune of Rs 13,021 crore while foreign institutional investors have been net buyers to the tune of Rs 46,196 crore (roughly $10 billion). By inference, Indian retail traders and operators have also been net sellers. The difference in attitude became more stark in September. FIIs bought a net Rs 23,612 crore while DIIs sold a net Rs 12,907 crore. Obviously the FII buying over-compensated for the bearish local stance as the Nifty rose by 11.5 per cent in September. It is moot which set of investors is more “correct” in its respective evaluations. The Indian market is valued high, with the Nifty held at a weighted price-earnings ratio (PE) of 25.6. It must be remembered, though, that historically values in this range have been sustained only for very short periods.

A PE ratio of 25-plus is also difficult to justify in terms of variables like interest rates, which dictate risk-free returns. It may be justified only if there is extremely high earnings growth through the next 12-18 months. While most advisories are positive, only time will tell if those optimistic expectations will pan out. There are two obvious structural dangers in this “one-legged” rally. One is an abrupt, deep correction if the FIIs suddenly change stance and start selling. It is impossible to assess the probability of such events. Turnabouts in attitude could occur for reasons unconnected with the Indian economy — another crisis in Europe or the US, for instance. The other danger is that Indian retail investors, who have eschewed equity investments since they suffered huge losses in 2008, will get sucked in by greed, just as the market peaks. If that happens, and the aam admi suffers another round of capital loss, his aversion to equity will become more marked. That could have unfortunate repercussions for upcoming IPOs and by extension, the public sector disinvestment programme. A level-headed approach to equities is, for all the above reasons, a good option.