The relentless climb of the stock market indices — the Sensex and the Nifty — invites a few comments. On November 5, the Sensex set a new record, when it crossed 28,000. It is still hovering around those levels. Normal profit-taking can lead to corrections, but the overall trend seems positive. It is a sign of the times that the record-breaking performance of the markets hardly elicits the excitement that was customary during the previous leaps of the indices. Evidently, not only the market participants but the public at large seem to take these high valuations for granted.
That could be a facile, even costly assumption. The factors that are driving up share prices need to be scrutinised constantly. A number of hypotheses trying to explain today’s markets fall flat even on a cursory scrutiny.
Recommendations to retail investors from a variety of analysts, brokers and the like reek of over optimism. Such exaggerated forecasts have been common at times like these — when calculated reasoning is replaced by unjustified optimism. The danger lies in not only retail investors entering the stock exchanges at these levels. Even the officially recommended avenues for them, mutual funds, have been capitalising on the prevailing sentiment by some aggressive selling. A number of new fund offerings (NFOs), for instance, can deliver, if at all, only over the long-run. They will be investing the money collected at the currently high stock prices. To suggest that the new funds will start reflecting the current Sensex levels is downright dangerous.
The last budget changed the rules for taxing debt funds, thereby, providing a disincentive to their investors. Those who want to invest in the share market are by default encouraged to put their money in riskier equities. That, of course, was not what the Finance Minister intended. Debt funds such as fixed maturity plans were proving to be a hit by exploiting the tax advantage that obtained for investors in debt instruments. Bank deposits fared poorly on a comparative basis. One has to perforce look at the real reasons behind the high stock markets. The Modi factor is no doubt a positive factor but its most beneficial consequence has been to lift the prevailing mood. The advent of a stable, cohesive government at the Centre is an extremely favourable development.
In the short period it has been in power the government has demonstrated a capacity for being decisive — deregulating diesel prices, paving the way for coal mine auctions to name a few moves to remove the policy logjam. Yet as the Finance Minister has been saying recently economic reforms are a long range process. Even a seminal reform such as the GST will take time before it enters the statute books despite all these years of discussions and consensus building.
In an ideal situation, the stock indices should reflect the real economy. No one claims that in the present context the high stock prices indicate or are a harbinger of robust economic growth. For more than two years, the Indian economy has been growing at below 5 per cent. Growth prognosis for the current year (2014-15) at around 5.5 to 6 per cent sounds better, but hardly at levels that would set the markets on fire. Earnings of listed companies, though improving, are not good enough to justify their market valuations.
So it is once again the case of surging global liquidity lifting stock prices in India and other emerging economies. The role of foreign institutional investors has been crucial but overdependence on these flows can be dangerous. For, these fleet-footed investors can just as easily reverse directions. Over the past ten days, there have been developments in two developed economies that have had a direct bearing on the Indian markets. The U.S. Federal Reserve wound down its massive quantitative easing (QE) programme, which involved purchase of long–dated bonds. The money that was released boosted reserve money and kept interest rates low. The phasing out of this ultrasoft monetary policy was entirely expected. India has been much better prepared than it was when the Fed announced its intention to withdraw the policy in instalments in September, 2013.
A termination of the ultrasoft monetary policy means two or three things — no longer will funds flow as freely into India as before; the Fed withdrew the policy only after it was satisfied with the recovery in the U.S. in terms of employment and economic growth; that should normally signal a return of investors to the U.S. That has not happened probably because the Fed has promised to keep the interest rate low. Those reasons alone may not fully explain the equanimity with which the Indian financial markets have reacted to news of the termination of America’s ultrasoft policy. Quite unexpectedly, Bank of Japan announced its decision to expand its bond-buying programme — to 80 trillion yen a year from the present 60 to 70 trillion yen. The stated objective is to fight deflation. There is no doubt at all that a portion of the funds released in Japan will seek investment in Indian stocks. This again may not be a wholly welcome development from the point of view of India’s macroeconomic management.
Investors whether in Japan or the U.S. are for the short-term. The two countries have had their own purely domestic reasons — for the U.S. to end an unorthodox policy and for Japan to expand it. This point should never be ignored by India.
(This article first appeared in The Hindu dated Nov 10, 2014)