Is liquidity driving equity markets away from reality?

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Indian markets witnessed consolidation this week post touching new lifetime highs. While India’s economic situation is on the path to recovery after the second wave, markets are far outpacing this growth. Stock markets are a forward-looking tool and hence they are factoring in a lot of earnings growth despite the unknown hurdles from the future Covid waves.

But given the low-interest-rate environment and lack of high yielding investment avenues, investors continue to invest in stocks for their inflation-beating nature, disregarding any ifs and buts. India VIX has fallen from its highs of 80 in the early 2020s to as low as 15 now, pointing towards receding fear that continues to keep indices afloat.

However, not all liquidity is being directed towards the right stocks. Across global markets, there has been an emergence of “meme” stocks wherein retail investors have been pumping money without any fundamental logic. People are treating the stocks markets as a get-rich-quick scheme which is worrisome.

A similar trend is seen in IPOs with record subscriptions some crossing 100x as liquidity is rampant. Similarly, the unlisted space is also witnessing high demand, pushing share prices to exorbitant levels. From the listed stocks, travel, tourism and hospitality sectors have been trading near their highs despite the ground situation not being rosy. Given the steadfast rise in the markets which isn’t factoring in all the hindrances faced by the real economy, it is clear that bourses are assigning valuations based on future earnings growth rates that may not come to fruition. Investors should maintain a cautious stance and keep their FOMO aside before entering such stocks.

Event of the week

This week the Fed moved up its timeline for rate hikes as inflation rises in the US. With India registering May retail inflation at 6.3%, distinctly above RBI’s target territory and WPI inflation also rising sharply, the RBI too, could be forced to make a similar decision sometime soon, away from their current dovish stance. While they expect our overall output to fall by Rs.2 Lakh Cr in FY22, what is driving inflation is the decline in bank deposits (savings) and rising discretionary expenditure towards services and products other than essentials. During times of low-interest rates, such as now, investors tend to flock to higher-yielding instruments, unnecessarily driving up “meme” stocks and IPO oversubscriptions in the process. It would be crucial to watch how long the RBI remains comfortable with the current interest rate scenario as the inflationary pressure is building fast.

Technical outlook

After four weeks of consecutive green candle, the Nifty50 index closed negative for the week. The benchmark index was rising on slow momentum and formed a rising wedge bearish pattern which has eventually broken down. As the market is still over-bought in the short term, the Nifty index is expected to test 15,200 levels in the short term. There might not be a major decline immediately but profit booking cannot be ruled out. Immediate support and resistance are now placed at 15,350 and 15,900 levels.

Expectations for the upcoming week

Markets are expected to witness some profit booking to a broad range-bound correction as news toggles between vaccinations and the new delta variant causing the third wave. Any form of credit incentive to supplement health care infrastructure would be good news for equities. However, of late, worst-hit sectors such as entertainment, aviation, malls and hospitality and leisure have remained in focus on talks around loosening of restrictions in some states. We suggest investors to maintain a safe distance from these stocks rising on irrational exuberance. It would be prudent for investors to ride the bull wave in fundamental resilient companies only and avoid temptation in fancy fast-moving stocks. Nifty50 closed the week at 15683.35, down by 0.73%.

(The writer is head of equity research at Samco Securities. Views expressed are personal)