Liquidity plus retail dominance is a strong cocktail
The uniqueness of the ongoing bull market is its one-way character. Since the recovery began in April 2020 after the massive crash of March 2020, global markets, except in China, Hong Kong and a few others have been steadily rising without a major correction. This is unusual. Bull markets mature with corrections. This has happened in all bull markets, globally and in India. Analysis of bull markets of last three decades in India – 1991-92, 1994, 1998-2000, 2003-07 – will reveal the fact that all these bull phases were subject to corrections. The ongoing one-way bull market, which has pushed up the Nifty by more than 130 percent from the March lows, is an exception. It is important to know why?
There is a near consensus that this global bull market is driven primarily by the unprecedented massive liquidity injected into the global financial system by the leading central banks of the world, led by the Fed. Fiscal support, particularly by the developed countries, has also contributed. It is estimated that the combined monetary and fiscal stimulus has reached a mind-boggling figure of around $13 trillion. With limited travel and less avenues to spend, money has been chasing assets like stocks creating ‘asset price inflation’. Feeding this sustained rise in stock prices has been the so-called ‘Robin Hood phenomenon’ of newbie investors merrily trading in the market using modern tech apps. Amateurish retail money has been dominating the institutional smart money. Normally, smart money leads and retail investors follow. But in this bull phase retail has been leading and institutions, on fear of missing the market momentum, have been forced to follow.
This trend may change. Investors need to monitor the market for signs of a trend reversal.
For the last several months, retail investors have been accounting for around 45 percent of cash market transactions in the exchanges. All FII selling, whenever that happened, had been absorbed by retail and domestic institutions. For instance, when FIIs sold equity worth Rs 11308 cr in July this year, the markets should have corrected sharply. Instead the market rallied when retail and DIIs absorbed all the selling. A major trend reversal in the market will happen when the FII selling becomes too big for retail and DIIs to absorb. Now we don’t know what will trigger this trend reversal and when this will happen.
More often than not, market crashes are caused by unexpected events. The collapse of Lehman Brothers was one such black swan event. Expected events like ‘Tapering’ are unlikely to have a big impact on markets. Particularly, the coming Taper is likely to be a ‘Taper without tantrums’ unlike the ‘Taper Tantrum’ of 2013, because the coming taper is expected unlike the taper of 2013.
As I write, the Chinese Evergrande crisis has caused some ripples in global markets. The Chinese regulatory crackdown had impacted the Chinese and Hong Kong markets earlier resulting in more than a trillion dollar erosion in market cap. The Evergrande issue is aggravating the crisis. There are many who view the Evergrande crisis as China’s Lehman moment. But, since the Evergrande debt is not widely held, it is unlikely to lead to a contagion.
Investors have to be cautious at this juncture. Even though there are positive developments in the economy and the corporate sector, markets are richly valued and, therefore, vulnerable to corrections. Remain invested in high quality stocks, but be cautious.