Economists, analysts and columnists have discussed ad nauseam the slowdown in the economy, the government’s policy paralysis, the high fiscal deficit and the persistence of inflation. To this witches’ brew has been added, in recent weeks, the prospect of a drought. In these dire circumstances, one would have expected the stock markets to be weighed down by gloom. Foreign investors have even more reason to be despondent, scarred by the sharp depreciation of the rupee. Yet the MSCI India equity index has outdone the MSCI Emerging Markets index this year, not only in returns measured in local currency, but also in dollar terms. Foreign institutional investors have been steadily buying Indian equities, albeit in small quantities. Could it be that the critics doth protest too much? If the economic or political situation is as bad as is being made out to be, why should Indian equities outperform?
A closer look shows that stock markets across the world haven’t done all that badly, in spite of the global recovery rapidly running out of steam. Consider the MSCI index for the Eurozone whose returns, in Euros, are negative by a mere 0.22% this year, astonishing considering the mayhem in the region. To be sure, the Greek, Spanish and Italian markets have been pummelled black and blue, but there has been hardly any contagion affecting the European core. Similarly, the US markets have so far done remarkably well considering not only the very tepid recovery there but also the proximity of the “fiscal cliff”, when tax cuts expire and automatic spending cuts start taking effect, slowing the economy.
The answer is a simple one. Investors are betting on more easing by the central banks in the developed world, with QE3 in the US and similar measures by the European Central Bank. They are also hoping that politicians in the US and Europe will be able to pull back their economies from the brink. That is why markets sometimes move up on the announcement of weak economic data, in the hope it will force policy makers to act. Add to that the fact that fund managers have been sitting on cash and even a glimmer of optimism is enough to stoke a rally.
In India too, hope springs eternal in the investor’s breast. The markets are waiting for signals from the government that they will, at long last, act. But we are fast running out of time---numbers from fund-tracker EPFR Global show that India equity funds saw outflows in the third week of July, rattled by the monsoon risk. So far, all that we have had from the government are a few encouraging noises. Unless the promises are translated into action, the Indian market may not hold up much longer.
Fundamentals or hope of reforms: what explains equity market performance? Tell us at firstname.lastname@example.org