Interesting times for equity investors

Phase III of the general elections took place last week and Phase IV is going on as you read. So far, the stock market has held up well despite an undertone of nervousness. Foreign Portfolio Investors (FPIs) have poured close to Rs 60,000 crore into rupee assets (Rs 10,000 crore in debt) in March and April and the Nifty has hit new all-time highs.  

The FPI attitude can be explained by global developments. A slowing world economy is leading to a situation where major central banks do their best to maintain liquidity. High liquidity, with low or negative interest rates (as in the Euro and the Yen) encourages a "risk-on" attitude, which makes the potentially higher returns from equity attractive. Taking it further, third world equity is historically more likely to generate high returns. India is a big Third World economy, with a fair growth rate. Therefore, despite many strikes against it, India will receive more than its fair share of FPI attention. 

As of now, India faces policy uncertainty and a guarantee of populism, whatever the shape of the next government.  It has a slowing economy, with an ongoing banking and debt market crisis, and very high stock market valuations. The Goods and Services Tax (GST) hasn't settled down and high unemployment could translate into social unrest, given the extremely divisive campaigning by the ruling party. It is a sad commentary on the rest of the world that India is still at the top end of growth prospects. 

Domestic attitude is less obviously optimistic than FPIs. Domestic institutions have sold approximately Rs 5,000 crore in March and April combined. Retail has also been net sellers. However, mutual fund data indicates inflows of Rs 9,000 crore into equity funds in March. That's a fair number. April data is not yet out and April usually has a high inflow due to the fiscal changeover. 

Comparing mutual fund flows for 2018-19 over 2017-18, we see some interesting patterns. Income funds saw an outflow of Rs 1.2 trillion for 2018-19, compared to an outflow of Rs 5,851 crore in 2017-18. But income funds saw an inflow of Rs 13,856 crore in March 2019. 

Equity saw an inflow of Rs 99,087 crore compared to inflows of Rs 1.4 trillion a year ago. Money market/ liquid funds saw inflows of Rs 76,093 crore compared to outflows of Rs 2,936 crore.  However, money market funds saw an outflow of Rs 51,343 crore in March 2019 alone. Equity ETFs saw inflows of Rs 43,351 crore compared to Rs 23,958 crore. 

The enthusiasm for equity remains, and this buoyed up the market through much of the year when FPIs were net sellers. However the equity enthusiasm is less than in 2017-18. The switches in attitude about debt reflect the Reserve Bank of India's switch in attitude. The central bank decided to become accommodative late into the last fiscal, and it has started cutting rates and carrying out swaps.  At that stage, debt funds started to receive inflows, after seeing heavy redemptions earlier. The inflows into the money market reflect a flight to safety and the reversal of attitude in March indicates some investors are prepared to punt on longer-term debt, while others met tax commitments. 

The chances of stock market volatility through April-May remains. Investors will parse every phase of the election for clues as to the shape of the next government. If the BJP wins a second term, there will be an initial burst of enthusiasm, followed by settling down. The BJP would deliver continuity but its economic track record really doesn't inspire much confidence.

If there's a hung parliament, volatility will continue into June. If a non-BJP coalition comes to power, there could be a crash. Frankly, that would be the ideal situation for long-term investors.  A market where earnings are growing at single digits should not be trading at price-to-earnings multiples of 25-plus. If politics is a trigger for pulling valuations back to reasonable levels, well and good. 

Either way, there's a strong case for investing heavily through May-June. If the BJP comes to power, the market will continue to run up and you'll get fast returns. If the BJP doesn't come to power, you get a chance to average down the cost of acquisition. Given a three-year timeframe, staying with equity will be a safer investment strategy than switching out.


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