A sudden market rally

A sudden market rally

The sudden rally in the stock market has taken everybody by surprise. What explains the rapid rise? Can it be sustained? These are some of the questions investors would like answers to.

Everybody knows that a wave of money from foreign institutional investors (FIIs) has led to the sharp rise in the market. But FII net inflows were strong even in earlier months, after a sell-off in May. The reason that didn’t lead to a big rally of the kind we’re seeing now is simply because domestic mutual funds, faced with redemptions, were selling. The worst of that selling seems to be behind us now, while FII inflows have picked up this month. The combination of these factors has driven the market up.

It’s important to emphasise that the equities rally has been global, though the Indian market has done better than most. As a matter of fact, the MSCI World Index has done better than the Emerging Markets Index this month, indicating the broad-based character of the upturn.

What could be the reason for the optimism? One reason is the improvement in economic data coming out of the US and also China. Markets had become extremely pessimistic, with fears of a double-dip in the US taking hold as the leading indicators all pointed to a slowdown. That gloomy mood has now lifted and the markets have bounced back in relief. Another reason is the very low level to which interest rates have been driven down in the US. The yield on the US 10-year treasury note, for instance, fell from 3% at end-July to 2.5% by the end of August. That has possibly led investors to borrow more funds and park them in risk assets. That view is corroborated by the Bank of America-Merrill Lynch survey of fund managers for September, which says that hedge funds have increased their borrowings to levels last seen in March 2008.

How sustainable is the rally? Indian equities are expensive, and most experts are advising caution. But it’s worth noting that the trailing price-earnings multiple of the Sensex is only a tad higher than its level in mid-January. In a sense, the markets had been marking time since then before the current breakout.

On the other hand, most indicators are still signalling a global slowdown. A majority of economists believe that the Western economies will continue to languish until they finish deleveraging. The high price of gold, despite the recent surge in equity markets, reflects the uncertainties ahead. Nevertheless, the huge amount of liquidity unleashed by the central banks is likely to continue to rotate among various assets, periodically leading to rallies of the kind we’re seeing now.

How long will the market rally last? Tell us at views@livemint.com