Investors should maintain a longer investment horizon, advise experts
The last trading session of the previous week proved to be Black Friday for the Indian stock market which saw a loss of close to Rs 5.50 lakh crore Market Capitalisation (M-Cap) in a single trading session. This has once again brought to the fore the pertinent question of whether the recent bull run is sustainable? The retail investors who have entered the market at higher levels are asking themselves, whether it was a mistake to enter the market at much higher levels?
There is no doubt that the valuations at the current level are rich and stretched. However, the market experts feel that the market reaction to the rising US bond yields, in the US and India, including other world markets, was a knee-jerk reaction and the market was searching for a solid reason to correct, which was provided by the sudden spurt in the bond yields. The long-term India story remains intact and investors with the medium to long term (three to five years) horizon will be rewarded going ahead.
The rising inflationary expectations in the US and the consequent rise in bond yields have been a subject of intense discussion of late. US inflation is expected to rise in the coming months, and therefore, the US yields too. The 10 Year US treasury benchmark has already moved up swiftly to 1.50 per cent, a steep rise from its lowest point of close to 0.50 per cent.
Dr Joseph Thomas, Head of Research, Emkay Wealth Management, said, “The Fed Chair had indicated that economic recovery has a long way to go and the risks of runaway inflation are quite low. Rising inflationary expectations and the rising yields have a potential to adversely affect the equity sentiment and the equity markets”.
Prominent studies on a spike in bond yields and its impact on inflation, covering the last 150 years, throws up interesting results. These studies reveal that the optimal inflation levels are somewhere around 2 per cent to 3 per cent. With inflation below 3 per cent but rising, it is the time when the price to earnings ratio (PEs) rise, the valuations rise, and can sustain at higher levels. Inflation greater than 3 per cent impairs the market’s ability to provide positive real returns.
“But, for the US or the other economies, there is still much room left for inflation to reach the 3 per cent mark, which should afford the markets some solace. The US unemployment level is actually close to 10 per cent, and the Fed has indicated that liquidity support would continue till economic recovery is sustainable,” Dr Joseph said.
There is a feeling among the traders in the domestic market that as the bond yield rises, foreign portfolio investors (FPIs) may turn away from Indian equities and head towards the US for higher returns. This stance may negatively impact emerging economy currencies (especially the Indian rupee) which would depreciate on rising demand for the dollar. However, this could play out eventually in the future but in the immediate future, this may not be true for India.
Since pre-Covid, India has added more than $100 billion to its forex reserves. Due to the strong accumulation of reserves, RBI could be in a better position to handle any currency weakness being caused by rising bond yields and potential FPI outflows.
“Stable currency, strong economic growth, and a sharp rise in earnings could help India could sustain any global correction due to inflation and rising bond yields,” said Rusmik Oza, Head (Fundamental Research) at Kotak Securities.
Currently, bond yields haven’t touched worrisome levels and this appears to be a small correction in the bull party.
Nirali Shah, who heads equity research at Samco securities, believed that till the time inflation increases and is mild, equity will improve, of course with corrections. Inflation can be looked at like a burning flame, as long as the flame is low there is no harm but if the flame intensifies there could be risks of getting burnt.
The global rise in the commodity is also adding to the looming inflation worry. The rising bond yields have provided a positive impact on commodities as can be seen from the BSE Metal Index which is up more than 8 per cent this week. The rise in commodity prices would translate into higher manufacturing cost, as input cost rises, which in turn would lead to rising CPI.
However, gold, which is considered the best available inflationary hedge, is currently at its support levels and is not sending out any warning signals related to unusual inflation hikes. “Therefore, investors should not be worried about inflation and keep an eye on bond markets for now,” Shah said.
Experts are of the view that instead of market speculation about rising yield inducing inflationary pressure, one should trust more on what the US chair has reassured. It said that the low cost of money will remain intact till the economy is on track.
Devang Mehta, Head Equity Advisory, Centrum Broking, said, “Indian markets have seen a stellar rally in the past couple of months not only due to strong foreign flows but it is also based on improving macros and return of corporate earnings growth. The ingredients of a structural bull market remain intact for India. Such ebbs and corrections (which we saw on Friday) will provide opportunities for long-term investors to take advantage of volatility and accumulate quality businesses at reasonable valuations and price points.”
Oza said, “The Nifty-50 range of 13,000 to 14,500 is an ideal range to accumulate stocks from a two to three years perspective. Since valuations are still very much on the higher side, it is not wise to invest and expect healthy returns in less than one year.”
As stated earlier, most of the factors driving Indian markets are in place except for valuations. As we go into the calendar year, we could witness a further rise in bond yield which will lead to moderation in equity valuations thereby suppressing returns from a short-to-medium term. As time goes by, India’s valuations will moderate making it a good buy on the dips market going forward.
Oza said, “Our belief in economy-driven sectors has further strengthened after the budget. Few sectors and pockets that we can visualise can make money for investors given their past underperformance and potential recovery are banks, capital goods, construction, engineering, oil & gas, cement, real estate, and metals. Hence, one can have an accumulation strategy in economy driven sectors on every decline.”