The sell-off in smaller companies appears more severe (Photo: Mint)
The sell-off in smaller companies appears more severe (Photo: Mint)

Bears tightening grip on markets as foreign investors rush for exit

  • Since their record highs in late 2018, BSE Midcap and Smallcap indices are down 25.2% and 35.4%, respectively
  • After Sitharaman proposed higher income tax surcharge on taxpayers with income of 2-5 crore, FPIs have sold shares worth $1.87 billion in July alone

Mumbai: Indian stocks appear to be sinking gently into a bear market hug, shedding around $149 billion in investor wealth since 5 July when finance minister Nirmala Sitharaman presented her Union budget.

Though aggregate market value remains above $2 trillion, aggressive selling by foreign portfolio investors (FPIs) have driven benchmark indices Sensex and Nifty 6-7% below their record highs touched in June on concerns over tax proposals and disappointment over the budget lacking adequate growth impetus.

The sell-off in smaller companies appears more severe. Since their record highs in late 2018, BSE Midcap and Smallcap indices are down 25.2% and 35.4%, respectively. While there is no universal definition of a bear market, the one usually deployed involves a 20% fall in stock prices, coming at a time of widespread pessimism.

According to Gautam Shroff, co-head of institutional equities at Edelweiss Securities, there is a crisis of confidence due to uncertainty over budget tax proposals. “There is a lot of pain on the street. FPIs are selling while only domestic investors are supporting the markets," he said.

Shroff said the markets may move in a range due to absence of any positive triggers. “The Reserve Bank of India’s monetary policy stance may drive markets going ahead. Resolution in debt-laden companies may boost sentiment." However, he thinks if the markets fall further, there will be opportunities for value buying.

Markets had perked up after ruling Bhartiya Janata Party returned to power with a massive mandate. The market’s confident gait, however, started faltering soon after the budget and has not recovered since. The Indian economy is beset with multiple fault lines, with stagnant consumption and investment demand leading to a deep-set economic slowdown. In addition, slow progress of the monsoon could affect food prices and lead to generalized inflationary pressures. The overhang of bad loans in the banking and non-banking sectors also weighs heavily on investor sentiment. Weak corporate results have added to the sense of despair. On top of these negative sentiments, the budget seemed to provide the final tipping point.

(Graphic: Paras Jain/Mint)
(Graphic: Paras Jain/Mint)

Global influences are not too encouraging either, with uncertainty over the Federal Reserve’s monetary policy stance. The Federal Open Market Commission meets on 31 July and is widely expected to cut interest rates. In the meantime, central banks around the world have been buying gold, sending the precious metal’s prices up 0.7%. Geopolitical tensions have sent Brent crude prices up 1.5%.

Analysts said raising taxes may prolong the economic slowdown.

“The government’s decision to raise taxes on automobile fuels, gold and high-income households in the FY20 budget may have certain unintended macroeconomic consequences and may prolong the ongoing economic slowdown…The government’s decision to raise excise duty on diesel and gasoline by 2 per litre in the Budget will result in 28,000 crore of additional revenues for the government," analysts at Kotak Institutional Equities said in a report on 19 July.

After Sitharaman proposed higher income tax surcharge on taxpayers with income of 2-5 crore, FPIs have sold shares worth $1.87 billion in July alone, after making net purchases of $11.34 billion in the January-June period. Domestic institutional investors were net sellers of 7,609 crore shares till June, but there was an inflow of 13,167.73 crore in July, the highest monthly inflow so far in 2019.

“The recent budget announcement on taxation has adversely impacted investor sentiments and is reflected in the FPI outflows from the equity markets," said CARE Ratings. “Going forward, FPI flows into the economy will depend on the performance of key domestic macroeconomic indicators and policies pursued by the government."

The government’s proposal to source part of its borrowing from overseas markets, however, has seen the rupee gain 0.67% against the dollar.

Likewise, bond yields have fallen 31 basis points on expectations of reduced sovereign bond supplies in the domestic market.

Nomura expects the markets to get valuation support from lower bond yields. It said that further steps taken by the government and the Reserve Bank of India to infuse liquidity into non-banking financial companies should allay concerns of a deeper economic slowdown.

Incidentally, the bull market in the Sensex and Nifty, which began in March 2009, completed 10 years in 2019. It has been India’s longest and slowest bull market, with a CAGR of 16%. The BSE mid-cap index has outperformed the Nifty and Sensex with a CAGR of 18%.

According to analysts at ICICI Securities, empirical evidence is clear that it is practically impossible to gauge how low the stock price can go if it is caught in vicious cycle of deterioration in one or a combination of the following factors -- declining operating environment, deteriorating investor sentiment towards the stock, systemic risk, questions on corporate governance and risk of default.

“Our empirical analysis of sharp stock price corrections of more than 75% from their peaks during a two-year period since 2010 indicate very low probability of scaling back previous highs -- eight out of 228 stocks, which fell more than 75% over a two-year period since 2010, have been able to scale back their previous high," they said. They feel the key reason for this behaviour is difficulty in accepting the stock after the original attraction of the business model is shaken; this leads to a permanent de-rating of stocks.

Despite the sharp sell-off in equities, Sensex currently trades at 18.11 times based on FY20 earnings, against MSCI World at 15.80, indicating Indian markets are still expensive. The MSCI world index is a broad global equity index that represents large and mid-cap equity performance across 23 developed markets.

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