The Indian stock market is currently in a bull market that is more than twenty years old. It began in 2003 and since then the Nifty50 index has multiplied eleven times – an annualised return of 13 percent. However, the rise in stock prices wasn’t smooth and linear. There were occasional price corrections; two of them were major.
One occurred in 2008 with the onset of the global financial crisis of 2008-2009: then stock prices fell 53 percent over twelve months but fully recovered from the fall in the next twelve months. The other occurred in 2020 due to the national lockdowns imposed following the coronavirus pandemic: prices fell 30 percent in two months then recovered fully in the next seven months.
Eventually, all bull markets come to an end. Thankfully, before they are about to end, many of these bull markets show some common traits, which enable an investor aware of it to safeguard his portfolio from the ensuing doldrums. One such trait is a very high level of participation by retail investors in the markets. Two measures – new demat account openings and the average daily trading volume (ADTV) – could help us determine the level of retail participation in the market.
Both made all-time highs in Dec. 2023, which were soon surpassed in the next month. What’s most striking about the increase in these two measures is their pace of increase. A total of 4.09 million demat accounts were opened in Dec. 2023, which was 47 percent higher than the 2.78 million opened in Nov. 2023. In Jan. 2024, new openings further increased to 4.68 million. Similarly, ADTV in the cash segment for Dec. 2023 were ₹1,13,674 crores, which was an increase of 49.75 percent from the ADTV of ₹75,913 crores for Nov. 2023. For Jan. 2024, these were ₹1,23,046 crores.
Other additional traits usually present at the end of a bull market are – a new all-time high in benchmark indices, an expensive valuation, and several IPO issues most of them of poor quality. Nifty50 is at an all-time high now. However, the P/E-based valuation of the index, although above its long-term median, is not at a level that could be considered expensive. Moreover, even though the IPO market has seen increased activity lately, the amount raised through the recent issues is not yet on a scale that could be termed as ‘hyperactive’.
Therefore, I have mixed feelings regarding the market’s prospect because it possesses a few, but not many, of the traits that appear at the end of a bull market. But if something baleful is to happen, I believe a price correction as seen in 2008 and 2020 is more likely than an end to the structural bull market that began in 2003.
The policy interest rate hikes by global central banks in 2022-2023 to fight high inflation were the steepest in 40 years or so. Although central bankers are not yet ready to claim victory over inflation, it has moderated significantly since then. However, what has perplexed market participants is the buoyancy of the global economy, particularly the US, because, historically, such steep interest rate increases have always resulted in a recession in the global economy.
Not many believe the recession has been dodged, but its likelihood of happening is much lower now than it was in early 2023. The general expectation now is an economic growth slowdown (soft landing) and the Fed to cut rates as soon as the slowdown is evident.
‘Lag effect’ might be one reason why the inevitable recession hasn’t yet materialised. The impact of interest rate hikes on the economy usually occurs with a lag – some say it is seven months after the last rate hike. If so, Feb. 2024 (seven months from July 2023, which was when the last rate hike was made) is when the impact of the interest rate hikes of 2022-2023 shall become evident on the economy. This means the first half of 2024 is a pivotal period for the global economy.
I wish to deliberate more on inflation and interest rates because they are the macro factors with the largest influence on markets. Even though the aggressive rate hikes of 2022-2023 have reduced inflation considerably, it is not yet fully anchored, and for the past few months has remained sticky at a level little above central bank target rates.
- In India, while the RBI has an inflation target rate of 4 percent, for three-fourths of the past year the CPI inflation has remained above 5 percent.
- Meanwhile, in the US, where the Fed has an inflation target rate of 2 percent, the inflation rate has been sticky at around 3.2 percent for the past eight months.
- In the Euro area, where the ECB has the same inflation target rate as the Fed, inflation has been sticky at around 2.9 percent for the past four months.
- In the UK, inflation has been hovering around 4 percent for the past four months.
Is Inflation in major economies staying tenaciously a bit above central bank target rates for some time a problem? I don’t think it is a matter of concern. However, what should be concerning is inflation rate staying above the policy interest rate for an extended period. Thankfully, due to the rate hikes of 2022-2023, the inflation rates in major economies now stay below their respective policy interest rates.
- In the UK, the policy interest rate is 5.25 percent against the latest inflation figure of 4 percent.
- In the US, the policy interest rate is 5.25 percent against the inflation rate of 3.2 percent.
- In the Euro area, the policy interest rate is 4.50 percent against the inflation rate of 3.0 percent.
- In India, the policy interest rate stood at 6.5 percent against the inflation rate of 5.10 percent.
However, too much anything is problematic. If the policy interest rate stays too high above the inflation rate, over the long run, this can hinder economic growth. But how much is too high of a policy interest rate? A rate differential of 1.5-2.0 percent between the policy interest rate and the inflation rate is considered conducive to sustainable growth. A differential above 2 percent carries the risk of putting brakes on economic growth in the near future. As per the latest figures, the rate differential for the UK, US, Euro area, and India stood at 1.25 percent, 2.05 percent, 1.50 percent, and 1.40 percent, respectively. All, except the US, have a growth-conducive rate differential, and even in the US, the breach is a tiny 0.05 percent.
Hence, although the inflation rates in major economies stay above their respective central bank target rates, a favourable rate differential between policy interest rates and inflation rates in these economies indicates an interest rate-inflation dynamics agreeable to sustainable economic growth. Maybe that could explain the buoyancy the global economy presently enjoys amidst the ongoing debate of whether it will have a ‘soft landing’ or a ‘hard landing.’
The enthusiasm surrounding India’s huge infrastructure spending – announced in last year’s budget – is shared at home and abroad. Perhaps a sub-sector within the infrastructure sector that has received the most attention would be the green energy ecosystem – an interconnected system that generates, distributes, and consumes energy from clean and renewable sources such as solar, wind, hydro, and geothermal power.
India’s large corporate groups have already announced massive investments in the green energy sector – the Adani group plans to invest $100 billion, Reliance has announced a $10 billion investment, and the TATAs will invest ₹60,000 crores. Though not with such intensity, a similar investment rush could be seen in the steel, automobile, and pharma sectors too. India FM in her interim budget speech earlier this month was enthusiastic about “private capex happening on a (large) scale.”
However, amidst this capital investment (capex) rush, we (equity investors) must be aware of two crucial things. First is that a significant capex by an investee company does not necessarily translate into a superior investment return for its equity investors. Oddly, history shows that stocks of companies undergoing significant capex generally underperform during the capital expansion phase. There might be outliers to this pattern, but they are rare; in most cases, underperformance is the recurrent pattern.
So, from an investment perspective, avoid getting enthralled by the excitement that usually accompanies such a large investment rush. A strong competitive position, superior profitability and cash flow, robust earnings growth and a fair valuation are the pillars of a good investment decision. You could have a lucrative investment experience in the long run if you don’t stray too far from those pillars.
The second crucial thing to watch out for during a capex rush is the likelihood of the initial excitement fuelling the capex rush enlarging into manias and developing asset bubbles. Manias are unsustainable… asset bubbles eventually implode… and the consequent distress and panic shall severely impact the general market and economy.
Our two recent constructive posts – ‘Financial Manias and Panics: A Short Primer’ and ‘The Crossover: When Manias Peak and Distress Follow’ – discuss financial manias and panics. I do not wish to repeat what is already written there. But I believe you will find it instructive enough to help you safely navigate a market engulfed by a mania or panic.
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