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A gush of liquidity from global central banks is driving equities up.
The BSE Sensex scaled a record high on Wednesday. But it isn’t just Indian equities that are doing well. MSCI’s emerging markets equity index is near a two-year high, the Indonesian market closed at an all-time peak and Korean equities shrugged off geopolitical concerns to hit a six-year high.
Liquidity is driving global equities up, despite little clarity on US policies, the threat of protectionism, geopolitical concerns and high valuations in some markets. This massive liquidity push is coming from global central banks who have added large financial assets to their balance sheets, which have kept the global equity markets supported despite the fundamentals still being on shaky ground.
The chart shows the rise in central bank assets over the past few years. A recent note from Bank of America-Merrill Lynch’s Michael Hartnett pointed out that the European Central Bank and the Bank of Japan have bought $1 trillion of assets this year. He said that the ‘liquidity supernova’ is the best explanation for the double digit gains in stock and bond markets this year. If the momentum continues for the entire year, it will amount to ‘the largest CB buying on record.’
In India too, key equity indices touched record high this week, but the rally here has been predominantly driven by fund inflows from domestic investors. While some analysts said that there are signs of earnings recovery, others disagreed saying, though corporate earnings have surprised on the upside, it is too early to call this an earnings revival. Also, on the valuations front, the Indian market is not cheap.
“Globally we are seeing equities gaining a fair share of liquidity and investors are willing to take risky bets and there could be a role of funds pumped in by global central banks in this surge. One must remember that expectations from India Inc earnings were pessimistic, so even if results are bit better the market is rallying; we expect earnings recovery to happen from the second half of the fiscal year, but that too will be on a lower base; this is all in all a liquidity driven rally,” said Mayuresh Joshi, vice-president and head of portfolio management services, Angel Broking Ltd.
To conclude, while the indices are on fire, fundamentals are yet to catch-up with the valuations, so investors should be cautious. “It seems to us that the sole investment thesis in some cases is ’liquidity’, which is quite bizarre since ‘active’ investors should be deciding on the fundamental value of stocks rather than leaving it to a nebulous issue such as ‘liquidity’,” Kotak Institutional Equities said in a report. The note also says that more earnings downgrades are expected due to a strong rupee and weaker volumes/realisations. It concludes, ‘It seems to us that ‘more’ money reduces ‘vigilance’ among investors.’