Enjoy the ride, cautiously

The bull-run in the market continues. Both Nifty and Sensex have been setting records in April. To understand the nature of this rally let us look at its important characteristics. This rally is part of the global bull-run in stocks in 2019. This has been triggered by the ‘risk on’ following the unexpected dovish Fed commentary of end January.  This rally is powered by a gush of foreign portfolio investment (FPI) liquidity.  ETF money and dollar carry trade are playing major roles in this rally, which is largely confined to the large-caps, particularly large-cap financials. The mid and small-caps, with the exception of a few stocks, continue to lag.

As on 19^thApril, the MSCI All country Index is up by 14.7 percent. MSCI US is up by 16.1   percent and MSCI Emerging Market Index is up by 12.8 percent and MSCI India is up by 7.2 percent (all in local currency). The conclusion is obvious: this is a global rally powered by global liquidity, which in turn, has been triggered by the surprise dovish stance of the Fed. With all the major central banks of the world – Fed, ECB, BoJ and People’s Bank of China – in dovish monetary stance, the humongous liquidity in the global financial system is chasing risky assets like equity. The US 10-year bond yield is sharply down from 3.26 percent in October 2018 to around 2.5 percent now.

Apart from the robust FPI flows there are some domestic factors supporting this rally. Expectations of more rate cuts by the RBI, a normal monsoon forecast by the IMD, smart turnaround in exports in March and expectations of NDA coming back to power are positives. More importantly the market is optimistic about a sharp rebound in corporate earnings led by the banking majors.

What are the risks?

The biggest known risk is a change in the Fed stance from dovish back to hawkish. But the probability of this is low. Another major risk is the present global slowdown – the IMF has scaled down its global growth projection in 2019 to 3.3 percent from 3.6 percent in 2018 – aggravating into a global recession. A global recession will impact corporate earnings bringing the markets down.

Domestically, the biggest risk is a badly fractured election outcome with neither of the two large parties not participating in the government. The recent strength in crude is a negative. The slowdown in the Indian economy is another area of concern. With the indices at record highs, valuations have risen beyond the historical averages. Nifty is presently trading at around 19 times FY20 optimistic earnings. Valuation comfort is receding.

History tells us that it is impossible to predict the market: where it is headed and when and how it will turn in the short-run. Therefore, while enjoying the market ride, investors should exercise some caution.