The domestic investors are gradually becoming more cautious and shifting their position from growth stocks to value stocks. The best performers in the last one month are Pharma, FMCG, & IT.
The Indian stock market displayed strong resilience during the recent global sell-off. Over just 25 days, Japan’s Nikkei 225 index dropped by over 1/4th from its July peak to its August low. This decline had a ripple effect on nearby markets, leading to corrections of around 1/5th in both Taiwan and South Korea. In the US, the S&P 500 saw a 1/10th decline, with the tech-heavy Nasdaq dropping by 1.6/10th. In contrast, the Nifty50 corrected by only 0.5/10th, highly beating the global clampdown.
The sell-off in Japan was triggered by the reversal of the “carry trade,” a global financial strategy where investors borrow in yen and invest those funds in higher-risk assets such as equities and bonds, including cross-border investments for arbitrage opportunities. Yen is amongst the world’s most liquid currency, highly stable due to a developed economy and available at low interest rates.
Over the year, Japan’s interbank interest rate increased from 0.07% to 0.28% in June and then to 0.45% in July, leading to an appreciation in Yen. The USD/JPY exchange rate reduced from 162 to 142 between July and August, marking Yen appreciation of ~12%. Market expectations suggest that the BoJ may further raise rates in 2025 to control inflation and stabilize the currency, which has depreciated by ~40% over the last five years, from 106 USD/JPY.
An increase in yen interest rates and currency value poses challenges for carry trades, as it raises the cost of funding and servicing dollar-denominated loan. Although specific data on carry trade positions is scarce, it is assumed that a significant portion of these trades is linked to the Japanese stock market, which has experienced substantial declines recently. A similar, though less pronounced impact was observed in Taiwan, South Korea, and Nasdaq, indicating cross-country positions.
Factors that led to the plunge
Additional factors contributing to the market decline include weak economic data like joblessness in the US and waning enthusiasm for Artificial Intelligence (AI). There is a concern that the US economy will slowdown in CY25 & euphoria about AI is reducing based on quarterly results. And as all these states mentioned above and AI based companies are trading at historic high valuation, they are vulnerable to performing in the short to medium-term.
India was largely insulated from the effects of the cross-country carry trade. Whereas decoupling of the domestic economy and the stability of the Indian Rupee (INR) helped shield the Indian stock market. Concurrently, substantial inflows from domestic investors, including mutual funds and retail participants, are absorbing the selling pressure from FIIs, mitigating any adverse impacts. FIIs are net sellers in equity for the last one month.
In the long term, India’s economy is advantaged by strong domestic demand and the China Plus policy. The economy is projected to grow rapidly at a real rate of 7% in CY2025, while other economies face a potential slowdown due to high interest rates and inflation. Additionally, the ongoing moderation in crude oil prices resulting from the global slowdown and the influx of FII into domestic bonds are supporting the INR & forex positions, giving a short-term advantage too.
However, India is susceptible to global market fluctuations as the correlation with the Indian economy & stock market has increased over the years. Currently, domestic investors’ contrarian buying is providing some insulation. Today the global market is on a relief rally, presuming that the unwinding of carry trade is over. Yen will appreciate in the long-term due to hawkish BoJ policy. And a persistent global market weakness due to high valuations and an economic slowdown could negatively affect domestic sentiment and inflows.
The weak Q1 earnings report suggests a slowdown in earnings growth, which does not support for further upside in valuations, which are trading at premium. The domestic investors are gradually becoming more cautious and shifting their position from growth stocks to value stocks. The best performers in the last one month are Pharma, FMCG, & IT. As global uncertainty, geo-political risks and high valuation prevail, the risk is increasing that the domestic buy-on-dip strategy will be tested during the year. The peak of the fear is that it will transit to sell-on-rally.
First published in Mint