Why stock markets are jittery and what could happen next

Even though Indian markets have run up sharply, we are not in bubble territory.
Even though Indian markets have run up sharply, we are not in bubble territory.

Summary

  • While the election result and higher-for-longer interest rates in the US could deliver short-term shocks, long-term investors have little to worry about.

It’s all about the great Indian election.

Everywhere you look and listen, the narrative is related to the elections.

Will 400 paar happen for the BJP?

Is an upset possible, with the INDIA bloc gaining the upper hand?

Is there a clue hidden in the lower voter turnout?

And if this was not enough, to this list of election conundrums we have those related to the markets.

Why are the markets jittery? There’s a chance BJP may disappoint in the elections.

Wise TV heads talk about the satta market and what it’s saying about the likely election results.

In short, there’s enough to chew on.

And if that was not enough, today I offer, perhaps, a simpler narrative to understanding what’s happening in the markets.

Now before we proceed, I want to tell you that none of what I offer as an alternative is some breakthrough idea. It’s an effort at decluttering what’s happening around us today.

With that, let’s start.

First, irrespective of which side of the political aisle you sit, you will agree that economically, India is on a strong wicket. Very strong. We have a lot going for us and unless something dramatic happens (on the lines of a pandemic or some other global disaster), India should be able to deliver a strong performance over time.

What do we have going for us? The answer to that could fill a book. But suffice it to say that fundamentally speaking, the ingredients for success are there. Think land, labour and capital – the basic building blocks of an economy. There’s also a broad and gradually improving policy framework (and here I include things like education, healthcare and legal rights, among other things). Put all this together, and throw in some policy initiatives, and you have the solid growth that India has been experiencing.

Now, as I have written before, a strong economy does not guarantee a surging stock market (remember China?). And this brings me to the second point, which is that even though Indian markets have run up sharply, we are not in bubble territory. Take a look at the historical price-to-earnings chart of the BSE Sensex over the past 10 years.

Source: Screener.in
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Source: Screener.in

Of course, segments of the market are outlandishly valued or unbelievably cheap. But for the sake of simplicity we will stick to the BSE Sensex valuation as generally representative of the Indian markets. And that is clearly signalling that we are neither expensive nor cheap.

Given these two points – potentially strong economic growth and reasonable valuations – a long-term investor should generally consider this as a good time to invest.

But as I said earlier, the elections have muddied the waters, making some investors jittery. There are several scenarios that could play out here.

If the BJP gets more than 400 seats… that’s no longer priced in, so that would be a positive surprise.

If the BJP wins, but does not get 400 seats… this is priced in. So no surprises.

If the BJP loses… well, this is the shock scenario.

At the risk of underplaying the loss, history suggests that aside from the initial shock, markets come to terms with the new reality pretty quickly. And the reality is that a lot of what is happening in India today is irreversible. Sure, the policy framework could hurt or boost growth at the margin, but the elephant that is India will continue to move along.

At its worst, a potentially shock BJP loss is a reason to hold some cash for bottom-fishing. That’s it.

Aside from the elections, there’s another factor that is playing havoc with the markets – the strong US economy. This, by implication, means interest rates there are not coming down any time soon. While there are several reasons why foreign institutional investors (FIIs) have been net sellers in India (election jitters, China’s revival, profit-booking, etc), this is perhaps the biggest one.

In April, FIIs were net sellers to the tune of 35,692 crore in the cash market. In May so far, they have already clocked net sales of 33,540 crore. These are big numbers. Had it not been for strong buying from domestic institutions (including mutual funds), it would have been interesting to see how this hammered markets – if at all.

Then again, like the elections, this is perhaps a temporary phenomenon. Expectations of lower US interest rates have not been junked – they have just been deferred for a few months, perhaps longer. Either way, this is but a temporary technical factor. (The flip side is that a lot of foreign money is heading our way on account of India being added to global bond indices. But that’s going to debt, not equity.)

The narrative so far is of a strong economy and broadly reasonable valuations on one hand, and an election result and higher US interest rates on the other. There’s nothing that should make a long-term investor jittery.

But markets are usually focused on the short term. So what’s happening around us should not be surprising.

What does all this mean for you, a long-term investor?

Well, I won’t be surprised if you are rubbing your hands in glee, as short-term factors can throw up some juicy long-term investment opportunities.

Irrespective of which narrative appeals to you, and how you decide to play it, be sure to stick to a sensible asset allocation plan. In the long term that’s what will largely determine how much wealth you create.

Rahul Goel is the former CEO of Equitymaster. You can tweet him @rahulgoel477. 

You should always consult your personal investment advisor/wealth manager before making any decisions.

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