Liquidity-driven markets call for systematic investment plans
Stock markets, globally, are on a roll. The Dow and S & P hit all-time highs in July. Japanese Nikkei and German DAX shot up by 6.4 per cent and 6.6 per cent respectively in July. BSE Sensex at around 28000 in mid August is up by more than 20 per cent from the low of 23002 touched on February 29. Other prominent markets like UK, Canada, South Korea and Indonesia are trading close to their record highs.
Why are the markets so bullish? Is there a disconnect between fundamentals and the market since global economic growth continues to be anemic? Is this the time to be cautious? Should the investors who did not participate in this rally jump on to the Bull bandwagon now? These are the relevant questions.
Make no mistake about this: this rally is about technicals and liquidity, not fundamentals. This is a global rally driven by liquidity. As on July, globally, around $13 trillion were invested in bonds yielding negative interest rates. Investors in bonds are sitting on capital appreciation since bond prices have appreciated consequent to interest rate cuts by Central banks. Therefore, investors in bonds are booking capital gains in bonds and switching the money to equities. This liquidity shift has initiated a ‘risk on’ in global stock markets. Emerging markets are attracting a fair share of these funds resulting in the EM rally powered by global liquidity. FIIs invested $1.4 billion in India in July taking the year to date investment to $4.3 billion.
At 28000 Sensex, the FY17 forward PE is 17.5 assuming Sensex earnings of 1600 for FY17. This is higher than the historical average of around 15.5. Mid and small cap valuations are looking very excessive in some pockets. PE of 17.5 is not excessive. Liquidity can take the markets much higher. Valuations are a bit of a concern since earnings potential does not look very bright presently. But there are many factors in favour of the Indian economy and corporate earnings. The monsoon which has been good so far, the reform push by the government in areas like FDI, GST bill getting passed, the beneficial impact of the 7th Pay award etc. are favourable factors. However, it is important to note that the dominant factors fuelling this rally are the humongous liquidity available in the global financial system and the negative yield on bonds, which are causing this liquidity shift to equity. Therefore, any development that adversely affects liquidity inflows, like rate hike by the FED, will impact the markets. Hence, investors have to be cautious.
Midcap index is at all-time high. Some mid and small caps are in the ‘bubble’ territory. Investors may book profits in those small and mid caps that have run up too fast and invest the money partly in fixed income. Investing in liquid funds and opting for Systematic Transfer Plan also may be considered. Though large caps still have some valuation comfort, the margin of safety is low. Hence, those investors who missed this Bull run should be careful. Refraining from investment also may not be a good idea since liquidity surge can push the markets higher. Instead of making large lump sum investments, investing through SIP (Systematic Investment Plans) would be the ideal investment strategy.
(The author is Investment Strategist, Geojit BNP Paribas)