In a song from Rajnikant’s Padayappa, the hero urges you to climb the peak, and having scaled the peak, to ascend to the sky — Freshdesk founder and CEO Mathrubootham cited this as his inspiration, after his company’s $1.03 billion public issues and listing on Nasdaq. That is not an option for Sensex.
At 60,000, the Sensex represents the valuation of Indian stocks at an 80 percent premium to other emerging market peers. This is not sustainable, and there has to be a correction, whatever the specific trigger. Investors, who are riding this exhilarating surge, would be well advised to diversify to fixed income within India and to other geographies.
The India story is strong, even if at the end of the current fiscal, the economy does not quite reach the size it had at the end of fiscal 2019-20. Analysts expect corporate earnings that matter for Sensex or the Nifty to grow a robust 35 percent next fiscal.
The pandemic is stabilizing, fresh infections declining and vaccination progressing at a rapid clip, albeit it could have averted tens of thousands of deaths that occurred during the second wave if the government had ordered vaccines at least when Serum Institute began to invest in an expanded capacity to produce the AstraZeneca vaccine late last year.
But the stock market has not been zooming only because of the strength of the Indian economy and the likely profitability of Indian companies. One primary driver has been liquidity, washing ashore on Indian bourses from where it has been created by fiscal expansion and bond purchases by central banks, totaling trillions of dollars in the US, Europe, Britain, and Japan.
Interest rates are depressed across the developed world and large pools of capital scour the world in search of higher rates of return. In calendar 2020, $14.035 billion of net portfolio investment came to India. The figure so far has been over $12 billion this year. Some of these flows would reverse when extra-accommodative monetary policy in the West and Japan sheds that extra and turns accommodative. And that could create a chaotic fall in stock prices in India.
The US Fed said earlier this week that it could begin tapering its asset purchases — it has been purchasing, since June 2020, $80 billion worth of treasuries and $40 billion worth of mortgage-backed securities every month — later this year, and wind up the asset purchases by the middle of next year. This would tighten yields, even if there is no direct action on policy rates by the Fed. The European Central Bank has already pared its asset purchase program, and the yield on some German bunds has moved out of the negative territory.
When the yield on risk-free government bonds in rich countries goes up, some portfolio reallocation happens among global funds: to maintain the same rate of aggregate return, they now need to expose themselves to less risk in the emerging markets, and they would pull some money out of risky places to the security of their own home markets. This would take away some liquidity from emerging markets such as India, and put downward pressure on stock prices.
Then, there are risks such as those emerging from China’s Evergrande, a giant property developer that owes $300 billion to bondholders, creditors, vendors, and home buyers. China’s authorities seek to wean people away from investment in real estate, which seems to be a Chinese obsessive-compulsive disorder.
According to one estimate, 96 percent of urban households in China already own one home, and many are seeking to invest in another one. To destroy the notion that investing in real estate is safe and remunerative, the simplest method would be to allow one more large developer to default on their delivery of homes and debt service obligations. However, if the scale of the default is huge, it could cause the system to seize up.
The Chinese authorities would, it is to be hoped, would find a happy mean between systemic disruption, which would spill over to other markets, and shock therapy for compulsive investment in real estate.
Right now, Evergrande has missed its $83.5 million coupon payment on its dollar bonds due on Thursday. However, there is a month-long grace period to make the payment. Only if it transpires that the company would default at the end of the grace period would investors abandon dignified, frozen panic and start a stampede.
It is not just foreign liquidity that has been pushing the markets up. Domestic liquidity creation has been plentiful as well.
The RBI is now devising new reverse repo routes to absorb the excess liquidity, and using forward trades in the dollar, rather than outright purchase of the greenback that pushes counterpart rupees into the system, to contain the volatility of the rupee triggered by excessive capital inflows.
Low interest rates mean that bank fixed deposits have lost their charm for middle-class savers, small saving schemes are not so liquid and have seen their returns pared steadily. So, savers have turned to mutual funds and direct dabbling in stock trading.
When markets stage a secular rise, everyone is an investing wizard. Those who make money when markets go down as well are the real wizards. Separating the wheat from the chaff will not leave the chaff particularly chuffed. So, it is best to leave wizardry to the wizards and for ordinary investors to diversify their investment portfolios.
A Morgan Stanley podcast, Thoughts on the Market suggests that European stocks are relatively undervalued. Geographical diversification is one option. Diversifying to debt mutual funds or subscribing directly to government bonds is another option. Ideally, the government should offer savers an option such as a bond that protects their capital and interest from the corrosive effects of inflation.
Remember that half-forgotten bit of advice from the past, to shun attachment to find happiness. Don’t be attached to every stock that has given you a decent return, diversify across geography, across different asset classes. So, book your profits, leave reaching for the stars from Mount 60,000 to SpaceX’s tourists, and clamber down to humble bonds, real estate investment trusts, and mutual funds that invest abroad.
This article was first published in The Federal titled Atop Sensex 60k, stop preening, start diversifying dated 25 September 2021
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About the Author
T K Arun, Consulting Editor, The Economic Times, New Delhi