10 warning signals even as liquidity drives stock prices higher
Unlike country-specific funds which have a longer term view, ETF flows are volatile and could reverse at the first sign of weakness. Also, India’s performance has to be seen in the context of the rally across emerging markets.
The overwhelming consensus is that strong global liquidity will continue to push stock prices higher even as valuations are completely out of sync with fundamentals.
A quick look at some of the factors that could play spoilsport, though they are being ignored for now.
Expensive valuations
The Nifty is right now trading at a price earning (PE) multiple of roughly 17 times one-year forward (aggregate) earnings. This is much higher than the long-term average of 14-15 times forward earnings. That’s not such a bad thing, because price earning multiples are high when corporate earnings growth is expected to be strong. Right now, the earnings growth--both trailing and expected—do not justify such high valuations. Analysts have warned of a steep fall if the PE were to revert to mean .
Colour of Money
Market experts say it is more of exchange traded funds (ETFs) that are pouring money into emerging markets like India. Unlike country-specific funds which have a longer term view, ETF flows are volatile and could reverse at the first sign of weakness. Also, India’s performance has to be seen in the context of the rally across emerging markets. Clearly, the strong FII flows of late have little to do with market fundamentals.
Mutual Funds
Net inflows into domestic equity mutual funds during the first half of 2016 at roughly Rs 13,500 crore are down 75 percent compared to the same period last year. Market watchers say retail investors are yet to regain confidence after the bruising sell-off during the early part of the calendar. If foreign capital flows dry up for some reason, there will be no cushion of domestic money.
Weak global growth
US’s disappointing second quarter GDP growth may hold back the US Federal Reserve from hiking rates in September, but also underscores the weakness in the global economy. Sluggishness in the major economies of the world is bad news for emerging markets in general. Dallas Fed President Robert Kaplan has said that the Fed must not overreact to the latest US GDP number and must consider more data when taking a view on hiking interest rates this year. Any rate hike proposal, even if expected, evokes a knee-jerk reaction from financial markets.
GST Bill
Expectations are running high that the Constitutional Amendment Bill for GST will be passed in this session of Parliament. A section of the market feels that the passage of the Bill could mark a near-term top for the market, given that implementation will take another year at least because of procedural issues. Also, some analysts feel a standard GST rate of 20 percent or above could be a dampener, as could be too much flexibility for states with regard to tax rates and the list of goods under GST.
Too much of a good thing?
Central banks were expected to flood financial markets with money to contain any volatility arising out of Brexit. Since then, Bank of England has held rates and so has Bank of Japan. Also, BoJ’s monetary stimulus was way below what the market had been expecting. Already, there is growing skepticism about the effectiveness of monetary stimulus in stimulating economic growth. BoJ’s pledge to step up purchase of exchange traded funds has been greeted warily by the markets, given the risky nature of the asset.
Rising indebtedness of emerging economies
Emerging market economies are becoming increasingly vulnerable to external shocks after a decade-long build-up of debt, says Moody's Investors Service in a report. The average external debt to GDP ratio for Asia as a whole has recently increased from 31 percent in 2008 to 47 percent in 2015 -- well below the 78 percent of Emerging Europe, but comparable to the 48 percent in Latin America and the 43 percent in the Middles East and Africa region.
Crude rout
Crude oil prices have slipped to a three month low, and many feel it is back into a bear market . Weak crude prices augur well for oil importers like India. At the same time, oil is also seen a proxy of the health of the global economy. Too much weakness in crude prices is not a good thing as it means pain for oil exporters which could then spill over to other parts of the global economy.
China’s shadow banking
China's "shadow banking" system is masking the rise in indebtedness in China, Moody's Investors Service said in a report earlier this week. Shadow banking is a term used to denote unofficial lending by regulated institutions. The rise in overall leverage and further expansion of shadow banking activity are pushing up financial risks in the economy, say analysts at Moody’s.
Troubled European banks
The latest European Union stress test has revealed chinks in banks in Italy, Ireland, Spain and Austria. "Whilst we recognize the extensive capital-raising done so far, this is not a clean bill of health," Andrea Enria, EBA Chairperson, said in a statement accompanying the results. "There remains work to do." There is speculation that some banks in Italy could be in big trouble shortly.
Unlike country-specific funds which have a longer term view, ETF flows are volatile and could reverse at the first sign of weakness. Also, India’s performance has to be seen in the context of the rally across emerging markets.
The overwhelming consensus is that strong global liquidity will continue to push stock prices higher even as valuations are completely out of sync with fundamentals.
A quick look at some of the factors that could play spoilsport, though they are being ignored for now.
Expensive valuations
The Nifty is right now trading at a price earning (PE) multiple of roughly 17 times one-year forward (aggregate) earnings. This is much higher than the long-term average of 14-15 times forward earnings. That’s not such a bad thing, because price earning multiples are high when corporate earnings growth is expected to be strong. Right now, the earnings growth--both trailing and expected—do not justify such high valuations. Analysts have warned of a steep fall if the PE were to revert to mean .
Colour of Money
Market experts say it is more of exchange traded funds (ETFs) that are pouring money into emerging markets like India. Unlike country-specific funds which have a longer term view, ETF flows are volatile and could reverse at the first sign of weakness. Also, India’s performance has to be seen in the context of the rally across emerging markets. Clearly, the strong FII flows of late have little to do with market fundamentals.
Mutual Funds
Net inflows into domestic equity mutual funds during the first half of 2016 at roughly Rs 13,500 crore are down 75 percent compared to the same period last year. Market watchers say retail investors are yet to regain confidence after the bruising sell-off during the early part of the calendar. If foreign capital flows dry up for some reason, there will be no cushion of domestic money.
Weak global growth
US’s disappointing second quarter GDP growth may hold back the US Federal Reserve from hiking rates in September, but also underscores the weakness in the global economy. Sluggishness in the major economies of the world is bad news for emerging markets in general. Dallas Fed President Robert Kaplan has said that the Fed must not overreact to the latest US GDP number and must consider more data when taking a view on hiking interest rates this year. Any rate hike proposal, even if expected, evokes a knee-jerk reaction from financial markets.
GST Bill
Expectations are running high that the Constitutional Amendment Bill for GST will be passed in this session of Parliament. A section of the market feels that the passage of the Bill could mark a near-term top for the market, given that implementation will take another year at least because of procedural issues. Also, some analysts feel a standard GST rate of 20 percent or above could be a dampener, as could be too much flexibility for states with regard to tax rates and the list of goods under GST.
Too much of a good thing?
Central banks were expected to flood financial markets with money to contain any volatility arising out of Brexit. Since then, Bank of England has held rates and so has Bank of Japan. Also, BoJ’s monetary stimulus was way below what the market had been expecting. Already, there is growing skepticism about the effectiveness of monetary stimulus in stimulating economic growth. BoJ’s pledge to step up purchase of exchange traded funds has been greeted warily by the markets, given the risky nature of the asset.
Rising indebtedness of emerging economies
Emerging market economies are becoming increasingly vulnerable to external shocks after a decade-long build-up of debt, says Moody's Investors Service in a report. The average external debt to GDP ratio for Asia as a whole has recently increased from 31 percent in 2008 to 47 percent in 2015 -- well below the 78 percent of Emerging Europe, but comparable to the 48 percent in Latin America and the 43 percent in the Middles East and Africa region.
Crude rout
Crude oil prices have slipped to a three month low, and many feel it is back into a bear market . Weak crude prices augur well for oil importers like India. At the same time, oil is also seen a proxy of the health of the global economy. Too much weakness in crude prices is not a good thing as it means pain for oil exporters which could then spill over to other parts of the global economy.
China’s shadow banking
China's "shadow banking" system is masking the rise in indebtedness in China, Moody's Investors Service said in a report earlier this week. Shadow banking is a term used to denote unofficial lending by regulated institutions. The rise in overall leverage and further expansion of shadow banking activity are pushing up financial risks in the economy, say analysts at Moody’s.
Troubled European banks
The latest European Union stress test has revealed chinks in banks in Italy, Ireland, Spain and Austria. "Whilst we recognize the extensive capital-raising done so far, this is not a clean bill of health," Andrea Enria, EBA Chairperson, said in a statement accompanying the results. "There remains work to do." There is speculation that some banks in Italy could be in big trouble shortly.
Happy Investing
Source:Moneycontrol.com
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