Equity markets in India continued to remain almost flat during the course of the month and have been trading within a narrow range since the day after the elections. Over the past few weeks, large cap companies have been trading in a narrow range, but one has been seeing increased strength in small and mid cap stocks. The fall in small cap stocks was severe last year and the pull back witnessed is very strong, bordering on exuberance. Since the portfolio has a reasonable mix of the large and mid sized stocks, the portfolio has seen some appreciation despite the Sensex & Nifty not showing any major gains.
One should also note that Indian market stability, over the month, in the context of a 23% fall in Chinese markets over the past month. Chinese and Indian markets are broadly clubbed together under the emerging market category by international investors and a steep fall in China, but no associated fall in India is a bit of surprise. Chinese government slowing down on the stimulus measures and been clamping down on bank lending. Over capacity in the system is a cause for concern. With such large fall witnessed in China over the course of the month, one need to be cautious in India too.
Indian markets is also seeing increased risk on valuation. India is among the more expensive markets globally and despite increased confidence, due to the economy coming out of recession, valuations among large stocks is not cheap. Several companies have also been showing inflated profits due to certain accounting umbrella provided by the government. Indian markets typically trade at between 12 – 20 x earnings. At current valuations, Sensex and Nifty companies are trading at closer to the top end of their historical range. Though market do trade above historical range at times, it is not sustainable. More importantly, underlying business sentiment is far from being strong to take equity markets beyond historical averages. Several of the portfolio companies are also trading near the top end of their historical valuation ranges and we continue to reduce holdings in companies that are expensive.
The monsoon has definitely dampened some of the sentiment and the government may have to stretch their deficits, if it were to spend its way out of the drought. The decision to slow down stimulus measures in India may be led by similar action in developed markets. In US, deficits are expected to be far higher than originally envisaged. Tax collections continue to be weak due to the economic slowdown. In India, the RBI governor has already voiced his concerns on the continued high government deficit and the risk of government borrowing having harmful effects on the economy. As and when the government chooses to tighten liquidity in the system, one should see a fall in equities. It is difficult to assess when policy would change course, but it would need to happen in the near future for the long term good of the financial system.