Melt-up worries

Bull markets, John Templeton said, are born on pessimism, grow on scepticism, mature on optimism and die on euphoria. If that is true, India’s bull market should be closer to its end-game now than at any time in the past four years. On Tuesday, as the Sensex 30 hurtled past 36,000 and the Nifty50 scaled 11000, voices of caution were drowned out by those celebrating the fastest 1000-point gain in the Sensex. India Volatility Index, the so-called ‘fear gauge’ has climbed a bit this past month, but the reading of 16 still signals complacency among market participants. But even as seasoned global investors ring warning bells on a stock market melt-up (the last phase of a bubble where asset prices rise rapidly before they crash), domestic market players continue to conjure up a variety of justifications for these gains — IMF’s bullish forecast, earnings revival, budget reforms, the January effect and surging domestic flows. But for investors, the fear of missing out is now trumping the fear of losing money, and this should make the regulator worry.

It is true that with year-to-date gains of 6 per cent the Indian market isn’t really an outlier. Euphoria over synchronised improvement in global growth has seen developed markets put on 6-7.5 per cent in this January rally. But Indian investors still have the most to worry about a possible melt-up scenario, because with the Sensex 30’s price-earnings ratio at 25.2 times, they are invested in one of the most expensive markets in the world. These steep valuations already factor in best-case scenarios on economic growth and earnings, allowing little margin of safety for disappointments. Inveterate bulls argue that this time it’s different because India’s stock rally in the last three years has been powered more by sticky domestic retail money, than fickle foreign flows.

But it would be unwise for SEBI to presume that all of the domestic money flooding into equities now is from patient or informed investors. There are signs to the contrary. Monthly SIP flows into mutual funds have doubled in the past year, showing that many of these so-called systematic investors are chasing recent returns. Flows from B15 cities are on the rise and that’s a worry too, though current rules incentivise this. Anecdotes of banks hard-selling equity products to fixed deposit investors abound. The flurry of penny stock ‘recommendations’ bombarding us through SMS and WhatsApp groups are proof that pump-and-dump operators are effectively using social media feeds to reel in the unwary. All this calls for SEBI and the exchanges to tighten their surveillance mechanisms and crack down quickly on suspected cases of stock price manipulation. It may also not be amiss for SEBI officials to talk down the market by alerting retail investors to the many signs of over-heating. After all, market intermediaries and funds have everything to gain from ballooning assets, and one can’t expect them to spoil the euphoric mood when the party is in full swing.

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