Markets now represent the triumph of hope over reality
A dovish Janet Yellen, once again signalling that interest rate hikes by the US Federal Reserve will be very gradual, was the excuse for another boost for global equities. That in turn, supported the Indian stock market, which has been on fire for some time now. As a result, key benchmark indices touched new record highs on Thursday.
The Sensex ended the session at an all-time high of 32,037 points, while the Nifty closed at a record high of 9,891 levels. Sector-wise, FMCG (fast-moving consumer goods), capital goods and banks were top gainers.
What also boosted bullish sentiment was the softening of domestic retail inflation in June, raising hopes of an interest rate cut by the Reserve Bank of India in August.
Apart from that, fundamentally nothing much has changed for the market to be continuously soaring to new highs. On the technical front, a significant amount of short covering was seen after the market regulator put restrictions on foreign portfolio investors from issuing participatory notes where the underlying asset is a derivative, technical analysts said. This factor has also been a contributor to the rally seen in the past few trading sessions, they added.
On the other hand, Indian equities seem to be ignoring an array of concerns. For instance, barring a few exceptions, the June quarter corporate earnings would be largely subdued with muted outlook. Yes, the goods and services tax is a major reform which the government has managed to implement, but the supply-chain disruption that it caused and the prevailing ambiguity on the tax will certainly weigh on the overall economy. Government data also shows a continuing slowdown in industrial production and no green shoots of a private capex revival.
Apart from liquidity, what has also worked in favour of equities in India is the under-performance of other asset classes, particularly real estate and gold.
However, despite that and given the aforementioned risk factors, the valuation at which Indian equity market is trading looks expensive. In July so far, MSCI India continues to trade at a 32.9% and 39.93% premium over MSCI Asia-ex Japan and MSCI Emerging Market indices, respectively. The level of complacency among market participants, which can be evaluated by the volatility index (VIX), is noteworthy. On Thursday, the India VIX or fear gauge stood at a low 11. According to some analysts, the market is in the overbought zone and looks ripe for a correction.
As the chart shows, the divergence between subdued earnings estimates and a soaring market continues.
“The Street’s tendency to ignore continued weak results and muted earnings outlook in certain ‘favoured’ sectors and stocks suggests that investors have high expectations (or hopes) about a strong recovery in profits of the ‘favoured’ sectors and stocks. It would be interesting to see if this ‘blissful’ state of affairs would continue if global bond yields were to rise on a sustained basis along with global inflation and earnings were to continue to disappoint,” said a Kotak Institutional Equities report.