Risks ahead, rewards too

There's no doubt that Indian markets are becoming increasingly aligned with global markets.

Mihir VoraLet us look at global and domestic factors that are likely to determine the course of the Indian market in the short term and the long term.

There’s no doubt that Indian markets are becoming increasingly aligned with global markets. The superlative performance of equities globally has primarily been driven by consistent and robust growth over the past three years.

However, there are some shortterm concerns. One of the key ones is inflation. Central banks all over the world have reacted to this by raising interest rates. The risk is that we may see a lagged impact of the hikes in terms of slower growth. The second concern is that global risk appetite had shown a sharp increase. This led to acceleration of capital flows to emerging markets. The flip side to this is that if risk appetite reduces, it can lead to a slowdown in inflows.

The third concern is the behaviour of the yen. It is one of the few leading currencies that have remained weak against the dollar. This combined with low interest rates in Japan has led to a large yen-carry trade (borrowing in yen and investing in asset classes in other currencies).

This is likely to reverse at some point in time, impacting many asset classes. Last, the problem in the US housing market persists and the markets out there are, for the first time, increasing risk-premium for certain loans like buyout funding.

Back home, domestic industrial production and GDP growth are still healthy. The Indian economy is expected to keep up the momentum. Equity market valuations are still not stretched overall. Although the P/E ratio for the market as a whole has risen since 2003, it has not risen much over the last year as earnings growth has been robust. Moreover, this ratio is still lower than levels that prevailed between 1995-96 and 1999-2000.

However, there are some factors that may create an overhang. On the economic side, inflation concerns still exist and the task of balancing inflation, the rupee and interest rates is complicated. On the one hand, while the appreciation in the rupee has been a damper on exports, rising imports have helped quell inflation but have resulted in a higher trade deficit. Also, rising interest rates may lead to a slowdown in rate-sensitive sectors like housing and automobiles.

From the trading point of view, we have seen a large build up of volumes in the derivatives segments, with outstanding positions and trading volumes touching all-time highs. This should be viewed as a signal for caution as the markets may be overheating in the short term.

So what should investors do? With volatility becoming a way of life, should you stay away from the markets altogether? No. Drastic falls in the price of stocks have their upside. It gives investors a chance to enter a bull run. Then again, it becomes difficult for a retail investor to time the markets correctly. So, to benefit from investments in equities, a disciplined approach is a must. With a 3-5 year view, the investor must invest in a planned, systematic manner.

Mihir Vora, Head of Fund Management(Equities), HSBC Mutual Fund