Equity markets were strong during the course of the month, catching up for the weakness seen last month. The Dubai crisis had some impact on the markets towards the end of the month, but so far seems to be shrugging away any major concerns. Sentiment in equity markets has been circumspect over the last few weeks and there is consensus building on the need for a consolidation after a spectacular period of gain during the earlier part of the years. The sense of caution is based on 2 extreme thinking in equity markets.
On the one side, the sense of optimism surrounding the future of the Indian economy is very strong in the eyes of the global investors. India is currently the 12th ranked economy in the world (see the attached document for more details on rankings), and with the Indian GDP expected to grow at over 7% per annum in coming years, it seems almost certain that India will improve its global ranking by at least about 5 notches over the next 10-12 years. Relative to other economies, India seems like a destination of choice. There are still several infrastructure projects where the return of capital is certain. Global capital has little choice, but to gravitate towards India, rather than risk the capital in other geographies. If the government executes its plans well, equity market returns in India can be very attractive in the coming decade. In addition, the governments of the world are keen on continuing a loose monetary policy that keeps liquidity levels high. The situation seems unlikely to reverse as long as governments can continue to borrow.
On the other hand, all investments needs to be viewed in the context of a price and valuations. Historical data suggests that stocks tend to trade within a certain valuation range and they are currently trading at closer to the expensive end of the historical valuation spectrum. Many promoters and companies are making use of the expensive valuations to raise capital. Amount of equity capital that has been raised over the past 4 months is amongst the highest one has ever seen inIndia. Over $ 20 billion has been raised as equity capital over the past 4 months, and not many of them at sensible prices for investors. Many of the large IPOs in recent times are trading below their issue price, which is a sign of trying to sell issues at expensive prices. Promoters willingness to sell parts of the company is also a sign of expensive markets.
The real question to address now is if equity markets can run up sharply from here onwards. The answer to this would probably be driven by government policy. But one thing is certain. As stocks become more and more expensive, the eventual correction would be equally severe. The probability of making good returns will diminish as markets becomes more expensive. Whenever large doses of liquidity is infused, capital markets tend to fail on its duty of efficient allocation of resources. Current conditions reflects the ill effects of excess liquidity, where untested companies are being provided with significant amount of capital for new businesses. Eventually, capital markets get back to their true role of allocating resources efficiently.