Low risk premium in equities sparks concern among fund managers that Indian markets may have peaked
Leading stock indices have declined by 2% in the past one week after a spectacular surge since Narendra Modi came to power. Conventional wisdom says this could just be a temporary phenomenon, but signals emerging from various circles suggest that the correction may have just begun and the indices may fall another 5-10% over the next few months.
This need not be in the context of only the Indian market; analysts say globally, too, several markets may see a correction. There are a few reasons for this contrarian view. John Mauldin, a best-selling author and a noted US-based financial analyst says in his newsletter that risk premiums for equities are quite low – something that was seen before markets entered into a bear phase.
Equity is the riskiest asset class and when people buy stocks at high prices expecting further return from that, they essentially see risk as much lower. Unfortunately, this also means ignoring risk associated with the asset class itself.
While Mauldin’s observation was also for developed markets, an analysis of the Nifty-based volatility index shows the index touched an all-time low level of 12.37 last Friday. Historically, from low levels, volatility increases when results in market fall.
Many investors might also sense a bit of déjà vu in this initial flurry of enthusiasm in the markets about Modi. When Shinzo Abe came to power in Japan, stock markets went through the roof in anticipation of firm steps to reinvigorate the economy. But the Street’s love affair with Abenomics has already started waning.
Some of the top fund managers are already seeing signs of cracks emerging in the post-Modi bull run. Though no one wants to speak on the record, one of them said, “Risk premiums for equities are low because valuations are high, which is why it will be difficult to make money in equities in near term from the current levels.” He says Indian equities will correct if the Bharatiya Janata Party (BJP) loses ground in state elections, crude oil prices reverse, or if foreign funds flow diverts to other markets due to high valuations here.
“One should stay as light as possible in the current market,”advised Sidharth Bhamre, head of equity derivatives and technical at Angel Broking. “Even foreign institutional investors are unwinding their long positions in the F&O segment at present and may start shorting if rupee weakens further and fall below 61.5 per dollar as lower currency washes out gains for foreigners in dollar terms.”
When the benchmark Sensex crossed 27,000 recently, leading investors started talking about 30,000 and 32,000 levels in the coming months. This raises concerns as fundamentals are yet to see that kind of improvement.
Consumer inflation is still high, industrial production has started falling and project investment and investment in capital goods has not seen real improvement. Mahesh Vyas, Managing Director & CEO, Centre for Monitoring Indian Economy (CMIE) said, “New project investment have not seen any significant improvements and till we see increase in capital goods orders, we will not see spike in new projects. May be, next fiscal we may see significant improvements.”
Though foreign fund inflow has been very good in the last few months, the rupee has not strengthened due to dollar strength.
Supporters of the bull market, however, say any corrections in Indian equities will be a buying opportunity. In the last six months, that is from March when Modi became prime minister, foreign funds have seen a significant 250% jump to date. Foreign Direct Investment (FDI) as well as Foreign Institutional Investment (FII) investments — in both equities and debt – in March to mid-September 2013 was $13.9 billion while in the current year, it is $48.4 billion, a large part of which is hot money.
Considering remittances of over $5 billion per month on an average and debt raising by corporates from foreign markets, the total foreign fund inflow from March has crossed $100 billion, which is 50% higher from the same period in the previous year.