Mumbai: Indian equities did well this year, beating most other markets. But then that was on top of a terrible performance in 2011, when we did much worse than others. And if we go further back, we find that the poor performance of Indian equities in 2011 was on top of a bit of outperformance in 2010, coming after a truly fantastic year in 2009, which in turn came after the disaster of 2008. How the markets do in a particular year seems to depend a lot on how it did in the preceding year. Indeed, if we assume this trend holds, Indian equities should underperform in 2013.
At first glance, it looks as if Indian equities have done well in a year when the economy has slowed dramatically. That would, of course, be too facile a conclusion. Consider, for instance, that the BSE Sensex is up only 4% or so compared with the high it reached in February this year, which shows how fast the market had run up at the beginning of 2012. It was only in September that the February highs were crossed. In fact, in some respects, the outlook towards the Indian market is now rather similar to what it was at the beginning of the year. At that time, there were two factors buoying the market—monetary easing by the European Central Bank (ECB), and the expectation that growth had bottomed out in India and the central bank would cut rates. The early hopes about higher growth and the transition to an easy money policy were belied, but they have now been revived. It is the hope of growth that has buoyed stocks.
Compare the market sentiment among fund managers in January with that prevailing now. The Bank of America Merrill Lynch (BofA ML) survey of global fund managers for January 2012 showed that world growth expectations had jumped, cash balances had fallen from 4.9% in December 2011 to 4.4% and there was a rotation out of defensives into cyclicals.
The recent December survey found that global growth expectations are at a 22-month high, cash balances are at 4.1% and sentiment towards China is fast changing for the better. The new worry, seen as the number one risk, is the US fiscal cliff.
Sentiment towards emerging markets has improved, with a net 38% overweight emerging markets, compared with 23% in December 2011. The survey’s Risk and Liquidity index—a barometer of global risk appetite—has gone up to 42 from 31 in December 2011. This renewed appetite for risk is also reflected in investors pouring nearly $45 billion (around Rs.2.5 trillion today) into emerging market equity funds this year, more than offsetting the $34 billion of redemptions in 2011.
It’s worth recalling, however, that the improvement in risk appetite was not uniform through the year. In June, for instance, the survey showed that hopes of growth had dissipated, cash balances were at an ultra-high 5.3% and equity allocations had been negative for three consecutive months. Since then, ECB president Mario Draghi has said that he will do whatever it takes to preserve the euro, US Federal Reserve (Fed) chairman Ben Bernanke has signalled unlimited quantitative easing and is trying to offset the damaging effects of fiscal restraint, and a new government in Japan wants an ultra-loose monetary policy.
But the unfortunate truth of the matter is that if we take annualized returns for the last five years for the MSCI India equity index up to 24 December 2012, it’s a negative 1.8%. Many emerging markets have done better. These returns are in local currency terms and it’s worth remembering that inflation is much higher in India than in most countries, so real returns to domestic investors have been truly dismal. The annualized return for MSCI USA over the period is -0.8%. Since five years is also approximately the period of the global financial crisis, the irony is that equities in the US, right at the epicentre of the crisis, have done relatively well.
One reason why US stocks have gone up so much this year is that the loose monetary policy embraced wholeheartedly by Fed has led to a sharp drop in US bond yields. That has led to money flowing into US equities and to emerging market stocks and bonds. The JPMorgan Emerging Market Bond Index is up over 17% this year. Emerging market central banks, on the other hand, have been tightening policy, for reasons ranging from battling inflation to curbing housing booms. This monetary tightening has had a dampening effect on equities in emerging markets, which is now reversing as central banks there too start to ease.
The BofA ML survey says emerging markets this year have benefited from “two forces: decisive action from global policy-makers and a reacceleration in EM (emerging markets) growth”. So far, India has seen no acceleration in growth. But these two factors will drive our markets in 2013.