Will liquidity gush continue?

Domestic and global flows are expected to stay favourable till early 2018, but any market shock will test investor confidence

Benchmark indices gained about 28-29 per cent in 2017, their best yearly performance in three years. The gains came despite corporate earnings disappointing and the economy growing at a sluggish pace. Many stocks saw their valuations get rerated, taking multiples way above their historic averages. This was made possible by the highest-ever investments by domestic mutual funds (MFs) and supportive global portfolio flows.

The rally in stocks is expected to continue in 2018 on hopes of a revival in corporate earnings and economic growth. However, as demonstrated in 2017, market’s fortune will largely be linked to how liquidity — both domestic and global — pans out. Stepping into the New Year, there doesn’t seem to be any pertinent concerns that will spoil the fund flow party. Thanks to increase in financialisation of domestic household savings, money continues to flow into equity MFs. On the global front, too, though the US Federal Reserve (Fed) is moving towards unwinding of its quantitative easing (QE) programme, other liquidity outlets — European Central Bank (ECB) and Bank of Japan (BoJ) continue to pump money. This is ensuring benign liquidity conditions, which are eventually finding their way into riskier emerging markets (EMs).

Equity strategist are forecasting the market dream run to continue till the first half of 2018 but don’t rule out shocks, as liquidity supply is expected to tighten in the latter part of the year.

“One other difference between 2017 and 2018 is Fed’s upcoming balance sheet reduction and QE unwinding programme. While in 2017 it was all talk about unwinding balance sheets, in 2018 we get to learn how that will actually impact markets when the actual unwinding starts,” says Herald van der Linde, head of equity strategy for AsiaPacific at HSBC.

Robert Subbaraman, managing director and head of emerging market economics, Nomura adds, “We don’t see any significant risk in the first quarter of 2018. But, in the second or third quarter, we could see some market shocks from Fed normalisation. We are also concerned with what happens with the ECB and BoJ. This could cause a risk-off as investors will look to reassess the credit risk in the EMs.”

Strategist at Bank of America Merrill Lynch don’t rule out a possibility of a “flash crash” in the first half of 2018 as global central banks continue to withdraw liquidity. The US-based bank says total central bank liquidity infusions will peak in the June 2018 quarter.

If the coordinated global asset inflation pauses, ends or reverses it will hurt Indian equity prices, says SanjayMookim, India Equity Strategist, Bank of AmericaMerrill Lynch.

Foreign portfolio investors (FPIs) inflows into Indian equities in 2017 totalled $8 billion, most of which found its way into Initial Public Offerings (IPOs).

Neelkanth Mishra, managing director and India equity strategist at Credit Suisse is more bullish on foreign flow outlook. According to him, India will continue to attract strong FPI flows as primary issuances in 2018 are expected to remain strong amid continuance of easy global liquidity conditions.

“With inflation staying low globally despite the commodity price increases, the withdrawal of central bank accommodation is unlikely to be sudden. The aggregate balance sheet of developed market central banks will barely change in 2018,” says Mishra.

Meanwhile, the liquidity outlook on the domestic side appears to be much more sanguine. Average monthly inflows into equity schemes in 2017 were close to ~12,000 crore. This momentum is expected to sustain, say most experts.

“Domestic households continue to make a shift away from gold into equities – a structural trend we expect will persist in 2018,” says Ridham Desai, managing director, Morgan Stanley India.

Experts believe investors have poured money into equities due to lack of alternative investment options--with global and real estate prices remaining soft. Poor returns in other asset classes will drive more investors towards equities, they add.

Another reason for sustained flows into equities has been low volatility in 2017. But, experts say a spike in volatility or frequent shocks to the market could test investors’ risk appetite and dwindle flows into equities.