Market Outlook
Heading for Higher Volatility
Market performance to be dependent on sentiment of domestic investor , as FIIs may not be supportive
Dhananjay Sinha Head of Research , Economist and Strategist , Emkay Global
Financial Services Ltd
The market has been in mild correction mode since January 2018 , with the benchmark indices falling by around 10 per cent . But bigger declines have been seen in the broader indices – BSE small and mid-cap indices have declined by 12 per cent and 17 per cent , respectively . The key question now is : should one start bottom-fishing , or will there be a further downside ?
The answer lies in understanding the backdrop of the huge 40-50 per cent gains seen in 2017 following demonetisation and the GST-led turmoil . Importantly , the strong upswing in 2017 changed the market narrative , which was built around the growing strength of domestic investors and structural financialisation of the Indian households ’ savings .
FII portfolio flows into Indian markets have been patchy , and there was also a perception that the markets can rally on the back of large retail inflows into domestic mutual funds ( MFs ). This , in a way , was reminiscent of the misplaced decoupling theory that had gained currency in 2007 , implying that the Indian markets can defy FII selling .
The other aspect of the domestic participation in Indian stocks is even more backdated . The second leg of the bull market since the 2009 low started with the formation of the Modi government . This phase , since May 2014 , has been dominated by domestic retail participation , which reflected in robust inflows into equity MFs after six long years of continued redemptions .
Thanks to demonetisation and GST shock-led deceleration , domestic equity MF flows ballooned further from an average of `5,400 crore per month to a high of over `10,000 crore per month during 2017 . Concurrently , the enthusiasm of FIIs for Indian equities started fading from mid-2015 .
Also relevant is the fact that the earnings trajectory of Indian companies has deteriorated since 2014 , with average earnings for benchmark indices remaining stagnant . This follows an average earnings growth of 8-10 per cent during FY08-FY14 . So , clearly , the rise in PE multiples to the January 2018 peaks ( benchmark trailing PE rising to a recent peak of 25x and that of mid-cap indices to 56x ) was purely backed by liquidity flows chasing valuation re-rating .
From here on , the outlook for the Indian market will be crucially pivoted on the sustainability of the positive confluence of domestic investor sentiment and MF flows that have prevailed so far since 2014 , particularly since the end of 2016 .
In my opinion , the outlook is shaky despite the possibility of some improvement in earnings ’ growth trajectory . The concerns are multi-fold . First of all , the price correction in the equity markets , more so for the broader indices and particularly in small and mid-cap stocks , can trigger liquidation of MF investments by domestic investors .
Our analysis suggests that of the inflows from retail investors into equities and equity MFs over the past three years , nearly 50 per cent is cyclical in nature and vulnerable to market vagaries .
Secondly , tightening of domestic liquidity in 2HFY2018 is reflected in rising money market rates and the steep rise in Indian G-Sec yields . In the past eight months , Indian ten-year benchmark yields have risen from a low of 6.4 per cent to ~ 8 per cent . Therefore , the surfeit of domestic liquidity that was supporting domestic equity participation is fading .
Thirdly , ahead of the general election in 2019 , the political landscape appears to be changing fast with the evolving conviction for domestic investors getting weaker than it was prior to the 2014 general election . And lastly , the rising global bond yields , driven by the strengthening scenario of fasterthan-expected normalisation of interest rates by the Fed , implies that FII support for the Indian market may not be very strong in the event of withdrawal of domestic MF flows .
To summarise , we are looking at a scenario of rising market volatility . It is likely that large-cap stocks with strong earnings visibility will outperform . Elections will throw up opportunities in the space of rural , agricultural themes , auto and farm equipment sectors . While hardening of G-Sec yield is on expected lines , in my view , low-duration money market funds can provide safety .
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Outlook Money April 2018 www . outlookmoney . com