The benchmark Nifty50 has oscillated in a tight range in the past eight weeks. On a point-to-point basis, it’s hardly changed - remaining mostly in the 19500-19700 range. More importantly, it has weathered a barrage of bad news in this period and stayed calm as reflected in the low volatility index.
Some of the noteworthy events weathered by the market include - hawkish commentary from central bankers (including the RBI and the US Fed); downgrade of global growth estimates; poor growth guidance by IT services companies; a truly ominous escalation of hostilities between Israel and Palestine; erratic monsoon season and consequently elevated food inflation & cloudy outlook for the rural demand leading to a sharp rise in global crude oil prices; opinion polls indicating some setback for the ruling BJP in the forthcoming state assembly elections; etc.
The bond yields in developed countries have risen to levels not seen in the past two decades. The US benchmark (10yr G sec) bond yields are presently close to 5% - a rise of over 700% in the past three years. Similarly, The Japanese and German benchmark (10yr G sec) bond yields have also seen a similar rise in the past three years. Conventional wisdom indicates that such sharp spurts in the bond yields invariably lead to the unwinding of leveraged positions of global investors, mostly resulting in a sharp correction in emerging market asset prices, especially risk assets like equity.
Notably, the emerging markets in general have underperformed the developed markets in the past year. However, the Indian equities appear to have performed mostly in line with the developed markets.
Besides, the broader markets in India have actually done exceedingly well in the past three years; with Smallcap and midcap indices sharply outperforming the benchmark indices. This trend has continued in recent weeks.
In fact, some global brokerages like Morgan Stanely and CLSA have upgraded Indian equities to “overweight” recommendation in their suggested portfolios. It is expected that these upgrades might stem, or even reverse, the net selling position of the foreign portfolio investors in the Indian equities.
In the given situation, a common investor in India may be faced with the following doubts:
(a) The financial conditions in many of the developed markets, especially the US, are deteriorating fast. If we evaluate the present conditions in the US markets, a sharp correction in asset prices (equity, bonds, and real estate) looks imminent. Chinese and European markets also look jittery. Under these circumstances, would Indian equities continue to do better or these also fall in line with the global peer?
It is pertinent to note that in 2H2007, the Indian economy and markets were also in a position of relative strength and had sharply outperformed. However, in 2008-09 we not only collapsed but also underperformed our global peers.
(b) The return on alternative assets like fixed coupon-bearing securities, precious metals, and cryptocurrencies now looks promising on a risk-adjusted basis. Would this lead to diminished flows in equities?
(c) Historically, positive real rates have resulted in the accelerated unwinding of the leveraged USD and JPY positions (popularly known as carry trade) globally. Would we see indiscriminate selling in India along with other high-yield (mostly emerging) markets, like all previous instances of such unwinding?
(d) Notwithstanding the improving breadth of earnings growth, it appears that the reported earnings may not match the market estimates of 18-24% earnings growth for FY24-26. Would this result in some PE contraction (price-led easing or through time elapse) of the Indian equities?
(e) If the Indian equities prices do fall, how much fall could be expected, and how long will this correction last?
My views on these issues, as of this morning are as follows. Please note that the situation is evolving very fast. It is more probable that my views will keep changing to suit the conditions as they evolve.
1. The Indian equities may correct 10% to 15% and not collapse (25% or more). 2023 is different from 2008 since the leverage at the corporate level and financial market level is significantly lower now as compared to 2008 and rates in India may peak at a much lower level as compared to 2008 (repo rate 9%).
However, the breadth of the fall could be severe. Many more stocks could see a fall of over 25% than the number of stocks falling less than 10%. It is therefore prudent to focus on the quality of the portfolio rather than gain potential.
2. On a 12-month horizon fixed coupon bearing securities could offer matching risk-adjusted returns to equities. However, beyond 12-months equities will continue to outperform alternative assets.
3. Unwinding of carry trade appears to be already in progress. In September and October, we have seen close to US$3bn net selling in the Indian equities. This may continue and even accelerate, causing deeper daily moves in the market.
4. I believe that a 10% correction in Nifty50 followed by a one-year time correction would make valuations reasonable.
5. In my view, in the worst case Nifty could possibly correct to 16880 level. However, the most likely scenario would be a fall to the 17895-18170 range followed by a consolidation phase of 6-8 months. Thus, a fall below 17895 would be an attractive buying opportunity, in my view.
