Friday, February 23, 2024

The market rally seems robust for now but caution never hurts

The Indian stock market appears to be in a favorable phase, where the stars seem aligned in its favor. With the price-to-book ratio for the Sensex stocks as a whole less than 3.5 and the PE ratio hovering in the mid-20s, stock prices are close to frothy, but not in bubble territory yet. This optimism is bolstered by the ruling Bharatiya Janata Party’s recent electoral victories in key north Indian states, suggesting possible policy continuity and an easy win in 2024. Additionally, India’s economy has shown unexpected growth, prompting the Reserve Bank of India to revise its growth projections upward.

While the markets were savouring this piece of good news, another major boost came from the US Federal Reserve announcing that it would not only not raise rates, but also indicated the possibility of three rate cuts in 2024. That carries with it the promise of inflow of foreign investment into capital markets, in search of higher returns in the world’s fastest growing large economy. Foreign portfolio investors (FPIs) have been net buyers in the recent past. In December, on every trading day except for one, FPIs have pumped in additional money. This has given an opportunity for some domestic institutional investors to book profits, as well

The inclusion of India in a key Government Bond Index, JP Morgan’s, is expected to bring in tidy sums of money into the domestic government bond funds. Some of the existing investors could well shift funds from bonds to stocks, further giving a boost to positive market expectations.

Domestic savings have begun a slow shift from safe but low-yielding bank fixed deposits to the capital markets. A considerable number of domestic savings have shifted to managed pools, including insurance, mutual funds and retirement plans. Over 2016-21, the volume of such funds has gone up from 41% of GDP to 57% of GDP, finds a Crisil report. These find their way to the stock markets, primarily, probably reducing the demand for second homes.

However, it would be wise to remember that markets are notoriously driven by greed and panic, both emotional states that persuade the normally rational person to suspend disbelief and expect the best or the worst. While so far, markets have been bountiful, they could punish as well. The global economy is going through a policy-induced slowdown, as many central banks have used elevated interest rates to tame inflation. India’s relative outperformance has helped funds flood in.

As economic growth bottoms out, or shows early signs of bottoming out, India would lose its relative sheen, and be forced to get along on its own intrinsic strength. Macroeconomic management, as indicated by the size of the fiscal deficit, public debt as a proportion of GDP, and the quality of government expenditure, with ballooning subsidies and welfare payments, does not offer much room for complacency. Private investment is yet to pick up, and the economy is steaming ahead on the strength of borrowed government funds.

The benign alignment of stars might prove less solid than it initially appears. The fault, as has been pointed out, lies not in the stars but in ourselves, if we suffer misfortune even as others seem to wax lucky. Enjoy the starlight, but let us not get starry eyed, either.

#market #rally #robust #caution #hurts

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