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Informist, Tuesday, Aug 6, 2024

 

By Anshul Choudhary and Apoorva Choubey

 

MUMBAI – Indian equities might not be able to replicate the high pace of returns seen so far in 2024 in the remaining months of the year as a confluence of unexpected global events has smothered risk appetite across global financial markets and intensified fears that corporate profit growth may slow down.

 

Domestic equities could continue to see higher turbulence over the next few weeks due to outflows from foreign portfolio investors, but the overall uptrend in shares will still remain intact over the medium- and long-term, due to strong domestic institutional and non-institutional inflows, said market watchers. 

 

Headline indices, the Nifty 50 and Sensex, lost 2.7% each on Monday, following deep losses in Asian markets, after the appreciation of the yen and fears of an impending recession in the US prompted investors to unwind currency carry trades. Both indices rebounded at open today and rose over 1%, only to give up these gains later in the session and close marginally lower. European and some other Asian equities also extended losses today, after sharp drawdowns on Monday. 

 

Markets may see volatility in the near-term as there are too many moving parts right now--recession worries in the US, unwinding of carry trades, and geopolitical issues in the Middle East (West Asia), said Sanjeev Hota, head of research at Sharekhan. Hota said it was difficult to ascertain the quantum of money tied up in carry trades across regions. 

 

A carry trade is a strategy where investors borrow from markets with low interest rates and a stable currency, such as Japan, to fund investments in higher-yielding assets globally. However, with the Bank of Japan raising interest rates last week and hinting at further increases, the yen has appreciated sharply, which has pushed investors to unwind their carry trades and cut losses. The yen has appreciated over 10% against the greenback in the last one month, after rebounding from levels of 142 hit on Monday to about 144 today.

 

"Japanese investors hold equities worth nearly 2.05 trln rupees in India and a stronger yen prompted some selling by such investors," Vikram Kasat, head of advisory at Prabhudas Lilladher Capital said in a note. A stronger yen could lead to liquidity problems in global markets as it would push investors to take more money out from global markets to pay interest on loans taken from Japan, an equity strategist with a domestic brokerage explained. However, the size of such carry trades is still not fully known, which is leading to concerns and fear of a drop in liquidity, he added. 

 

The sell-off in Indian equities on Monday was driven by foreign institutional investors, who net sold domestic shares worth 100.7 bln, as they sought to unwind positions in several Asian and emerging markets. This was the highest single-day sell-off by foreign portfolio investors since the day of the General Election results on Jun 4.

 

Adding fuel to the fire are worries of a recession in the US, which have intensified after the latest jobs report. Unemployment rate in the world's largest economy jumped to 4.3% in July. This is the highest unemployment level in nearly three years and marks the fourth consecutive monthly increase, noted Ajit Banerjee, chief investment officer at Shriram Life Insurance Co. Besides, poor manufacturing indicators and new order figures also exacerbated the fears over weakening of the US economy, he said.

 

There is also uncertainty due to tensions in West Asia, where US Secretary of State Antony Blinken has warned that Iran and Hezbollah may attack Israel. "Any retaliation there could further increase inflation, which can delay interest rate cuts (in the US)," Dharmesh Kant, head of equity research at Cholamandalam Securities said. The hope of interest rate cuts in the US has been one of the major reasons for the global equity rally seen this year, and has taken several indices, including the Nifty 50 and Sensex, to fresh lifetime highs. 

 

"These (global) developments are causing panic, particularly as Indian markets, which trade at high valuations, could also see some sell-offs," Vinit Sambre, head of equities at DSP Mutual Fund, said in a note. The Nifty 50 has risen 23% in the last one year, while the broader indices Nifty Midcap 150 and Nifty SmallCap 250 have given stellar returns of 46% and 49%, respectively. 

 

Thus, the rout since Friday has also been sharper in the broader market. The rally in Indian equities in the last one year has been led by companies which have lower than average business quality and lower than average growth profile, Vinay Paharia, CIO, PGIM India Mutual Fund said in a note. "We have been highlighting some of the micro-bubbles in the market for quite some time now, which we think are brewing in low growth-low quality midcap and small cap stocks, capital goods, defence and industrials sectors, stocks of newly listed companies and real estate sector," he added. 

 

So far in 2024, the Nifty 50 has risen 10% for the year, while the Nifty SmallCap 250 is up 20% and the Nifty Midcap 150 has gained 21%.

 

EARNINGS AT RISK

Earnings declared for Apr-Jun have showed that companies in several sectors are struggling to grow profits at the pace seen last year, as input price-led tailwinds have abated and topline growth remains elusive. While the earnings season has been largely aligned with projections, it has failed to provide positive triggers for future quarters, leading to a loss of momentum in shares and inadequate resistance against corrections, noted Banerjee of Shriram Life Insurance Co. 

 

The sharper-than-expected weakness in the US labour markets, a prolonged slowdown in China and recession worries in Japan increase the risks to consensus earnings estimates for 2024-25 (Apr-Mar), said brokerage Kotak Institutional Equities in a report today. "Even our conservative estimates may have downside risks, as exports and commodity-oriented sectors contribute to 35% of the net profits of the Nifty 50 index," it said. 

 

Geopolitical risks have increased in recent weeks, particularly in West Asia, which may impact oil prices, and Bangladesh, which may impact certain companies, the brokerage warned. Kotak Equities expects net profits of companies in the Nifty 50 to grow 9% in the current financial year and 15% in the next. 

 

However, the spate of recent negative news, including the sharp appreciation in the yen, deep slowdown in the US and Israel-Iran tensions, may or may not be enough to dent the confidence of retail investors, Kotak Equities said. The brokerage, though, warned that the most innocuous event or events can change sentiment quickly.

 

The risk appetite of retail investors is visible in the strong investments worth over 200 bln rupees through systematic investment plans, especially into micro-cap and small-cap schemes, as well as addition of new folios. Mutual fund schemes witnessed inflows of over 1.66 trln rupees in the first six months of 2024, compared with 1.61 trln rupees in the whole of 2023. 

 

These strong retail inflows have meant that every small correction in the market has been bought into, eventually, as mutual fund managers want to deploy cash. On Monday, too, shares dumped by foreign fund managers were picked up by domestic institutions, which remain beneficiaries of strong retail inflows. Domestic institutional investors net bought 91.6 bln rupees of equities on Monday.  

 

Today, too, a similar trend played out with foreign investors net selling domestic sharers worth over 35 bln rupees, while domestic fund managers pumped in 33.6 bln rupees, on a provisional basis. This trend is seen continuing as most participants expect foreign outflows to cause turbulence in the market for a few weeks, but this volatility may throw up opportunities for domestic fund managers to deploy cash, who remain bullish on prospects of India's long-term economic growth.  End

 

US$1 = 83.95 rupees

 

Edited by Aditya Sakorkar

 

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