Stock market slump is just the start
The slowdown in Indian as well as global markets may be setting the stage for a deeper correction
RAJASTHAN’S BYPOLL RESULTS AND THE BJP’S UNDERWHELMING WIN IN GUJARAT WOULD BE WORRYING THE STREET, WHICH MAY HAVE PREMATURELY PRICED IN A BJP MAJORITY IN 2019
In the perennial balance between greed and fear, greed has had a one-sided run. Now fear stages a comeback, reminding investors that what goes up, can also come down. It wasn’t Black Friday only on Dalal Street last week, the Dow Jones Index in the US also saw its biggest crash in nearly two years. Is the stage being set for a deeper correction?
At home, the immediate trigger was the imposition of a long-term capital gains (LTCG) tax on stocks. Despite this, equities may continue to deliver better post-tax returns than other asset classes like fixed deposits, bonds, gold and real estate, but it is still a significant regime change. The good old days of tax free gains are over.
What would worry investors more is the possibility that this may just be the beginning. Arun Jaitley used the words, “starting with a very small levy of 10%”, which may indicate that eventually rates may rise further. In time, it is entirely possible that short-term capital gains are taxed at the highest bracket of 30%, and the definition of long-term changes to two or three years for equities, in line with other asset classes. A door has just been opened.
It would be unwise to conclude that this is the only headwind for the stock market today. There are several. Notable among them is the fear of rising interest rates, local and global. The prospect of two successive years of fiscal slippage has already roiled the Indian bond market, with the benchmark yield spiking to 7.66 from 6.63 in just four months.
In an overdue reversion to mean, crude oil is also rearing its ugly head, which is bad news for Indian stocks. If this continues, bond yields will rise further and even the RBI will have no option but to raise interest rates.
This is a big risk for the Sensex. In fact, it is one reason why India has been underperforming among most big emerging markets like Brazil, Russia and China in 2018. Even in the US, rates are rising. The prospect of improving growth and rising inflation has seen US bond yields shooting up to 2.84%, the highest in two years. These are body blows for the rampaging bull. If global markets fall, India will fall with it, perhaps more.
As 2018 wears on, the other risk which may begin to rise silently, is politics. The stock market would have unpleasant memories of the India shining debacle. Shades of similarity are visible today — a booming Sensex and chest-thumping at Davos in the face of a struggling rural India. A recipe for political disaster. The Rajasthan by-poll results and BJP’S underwhelming win in Gujarat would be worrying the street, which may have prematurely priced in a BJP majority in 2019. Now, stock prices may begin to price in the probability of a slightly different verdict.
These risks come together at a time when Indian stocks are trading at very lofty valuations, which only compounds the problem. Midcap and small cap stocks, particularly, were trading at ludicrous valuations when the storm hit. Now these valuations will compress, as risks get factored in.
Also, the run in the market has been fuelled by a massive inflow of money from domestic investors into equity mutual funds. In 2017 alone, ₹1.2 lakh crore poured in. Many of these new investors have not seen what real market volatility can look like. They may now see the other face of this beast even as they get used to paying tax on their gains. It will test their conviction and courage; the stock market is no place for children. Time will tell if flows into the equity market will slow down from the heady pace of the last two years.
A correction was overdue. Making money had become too easy and investors had started confusing a market boom with great investing skills. The LTCG may have just provided an excuse, a trigger for the fall.
This now sets the stage for an interesting year ahead, leading up to the Lok Sabha polls. On the one hand, the support of a gradually improving economy and corporate earnings recovery, on the other, the risks mentioned, paving the ground for a delicate balance. And higher volatility. The bull is not dead, merely tired and wounded. It will return. But meanwhile, the forgotten bear may get a look in. And the new boys on Dalal Street, they will become men, the hard way.