A new high

Stock markets live on hope

Given the flurry of bad news over the weekend, there was little reason for the stock markets to rally the way they did on Monday. The Sensex closed above the 40,000-point mark for the first time and the Nifty went past 12,000, also for the first time. The March quarter GDP data was weak, suggesting an overall slowdown; auto sales for May continued to be poor and corporate earnings for the fourth quarter of 2018-19 were disappointing. India Inc’s leaders are also almost unanimous in their view that consumption, the only engine fuelling the economy, is slowing. Yet, the BSE Sensex is now trading at a two-decade- high price-earnings multiple of 29 times trailing earnings, as foreign portfolio investors (FPIs) keep faith in Indian markets. After being net sellers to the tune of Rs 34,000 crore in 2018, FPIs have brought in Rs 78,000 crore so far in 2019, fuelling the rally. 

The change in stance began in February when FPIs started pumping in dollars, with March 2019 being the second-highest net investment in the history of the Indian markets. The reason for their change in stance was the US Federal Reserve calling it the end of a rising interest rate cycle. As a result, US bond yields have declined from a decade-high of 3.24 per cent in November 2018 to 2.12 per cent now, which is nearly a five-year low. A lower bond yield and, by corollary, lower interest rates make equities attractive compared to fixed-income assets. 

With US bonds no longer being a high-yield safe haven and the Fed’s benign rate outlook, the risk-on trade took shape, and India was one of the highest beneficiaries of the flows. Along with the dropping yields in the US, the Indian 10-year benchmark yield too has fallen from its September high of 8.18 per cent to under 7 per cent on Monday. Brent crude oil prices are also down 14 per cent since mid-May, which brightens prospects for Indian companies as it will translate into lower input costs for Indian manufacturers and reduce the current account deficit for the country as a whole. From FPIs’ perspective, India is an attractive market, which still promises growth despite the weak Q4 GDP. Moreover, several global markets have been roiled by the US-China trade war but India is relatively insulated. Global brokerages, which had reduced the extent of their overweight position on India in 2018, have also increased it, attracting more money.

India’s valuation may be rich compared with its historical multiples, but the index earnings yield of around 3 per cent is still higher than US bond yields, providing enough incentive for foreign investors to make additional bets on Dalal Street. Also, periods of overvaluation supported by liquidity are not new to the Indian stock markets. Besides the fund flow, there are also other expectations built into the recent bull run. On an immediate basis, the market is factoring in at least a 25 basis point rate cut, to be a given at the monetary policy committee meeting this week. The market is also expecting some stimulus and higher spending from Finance Minister Nirmala Sitharaman’s Union Budget on July 5, which could revive demand and growth. A disappointment on any front from foreign flows, crude oil, demand conditions, or government policy could mean a nasty surprise for investors, as current valuations appear unsustainable.