The liquidity push

Higher valuations could increase volatility in the new Samvat

The markets have posted double-digit gains in Samvat 2076 with the indices touching new peaks, even though economic activities have taken a big hit. This might seem paradoxical, with many market observers saying financial markets are forward-looking mechanisms and investors are usually optimistic in their projections. But quite a few of them are finding it hard to find a rationale for a disconnect of this magnitude. The fact is that the economy will contract substantially and inflation is up. In a broader perspective, the global economy is also not doing well. The increase in the number of Covid-19 cases in a number of countries, including the US, has increased uncertainty. There is no end to the pandemic in sight yet in India as well, though new cases have declined. And even if economic activity recovers in the current quarter as many analysts are expecting, it may take a while before the economy re-inflates back to the size it was in 2019-20.

But a closer look suggests there has been a method in this perceived madness. There was a sharp sell-off early in the calendar year when the magnitude of the pandemic became apparent. But that has been followed by six months of strong recovery across listed stocks. Year-on-year, the Nifty is now up 6.9 per cent. One of the reasons is the availability of cheap liquidity, and the absence of alternative investment options. Interest rates are negative in real terms, which rules out entire avenues of investment. Real estate returns have been negative, with realtors struggling to place excess inventory. Ergo, investors have moved into equity for the lack of more attractive options. Incidentally, this focus on equity is a global phenomenon, with every major market up in the past six months. Among other asset classes, gold and cryptocurrencies are the only assets which have yielded decent returns. Both tend to gain during periods of uncertainty. Gold is a traditional haven. But Indian policymakers have blocked investments in cryptocurrency.

The second-quarter corporate results show easing in the contraction with some return of consumer confidence. The Reserve Bank of India could, therefore, be correct in asserting that the current quarter will deliver positive growth. A broad overview of Q2 results suggests that “small-ticket” private consumption has improved, with consumer goods companies doing reasonably well. Among the core sectors, steel and cement realisations have also picked up, while low energy prices remain beneficial. The agro-economy is expected to pick up, given a good monsoon. There are encouraging signs here, like strong tractor sales and increased offtake in agro-chemicals. But concerns remain in the automobile sector with significant inventory build-ups that dealers hope to liquidate during the festive season. Investment remains low, and credit offtake is anaemic. This would also mean earnings would come under pressure in the near-term and keep the valuations at higher levels. As the world advances towards getting the Covid-19 vaccine (expectations range from early to the middle of next year) and the economy gets back to normalcy, the economy-driven sectors can outperform the defensives. All this suggests that the new Samvat beginning Saturday could remain volatile with limited upside.