The month of September was a surprisingly bullish month for the markets driven by easing action by the US Federal Reserve, Stable economic growth parameters and finally economic revival measures announced by the Chinese authorities which added to the positive sentiments. FII flows picked up significantly during the month of September and crossed the entire flow for the first 8 months of the year 2024 and as is the case with most of the times this happens the large caps outperformed the mid and small caps. Nifty was up 2.3% during the month while the Midcap Index rallied just 1.5%.
The camps are currently divided into those who believe that the rally will continue given the huge funds flow into the stock markets and those who believe that a crash in the markets is imminent. The bulls say markets will keep on rallying and believe that the huge cash pile of Rs 130000 Crores with Mutual Funds, increased funds flow into Emerging Markets as interest rates come down and the US Dollar weakens as well as higher economic growth will keep the rally alive for much longer without any correction. Chinese stimulus will also support the markets. On the other hand the bearish argument is that there is too much euphoria around the stock markets, IPO supply is huge, there are geopolitical tensions and market valuations are much higher than historic valuations. Market Capitalization to GDP ratios across the world are also in bubble territory.
The reality could lie somewhere in between. While valuations and IPO euphoria are red flags into the markets there are two major criteria which I believe need to be satisfied for a big market top to be formed. Firstly valuations should be around 20-30% higher than current levels as was the case in both 2000 and 2008. Secondly inflationary pressures need to be high which the central banks are working on by removing liquidity or increasing interest rates, we are at the opposite at this stage and lastly there needs to be financial sector stress at some extreme level. While there are signs of some asset quality stresses they are not of the stage which indicate a crisis. The only big red flag is the Market Capitalization to GDP ratios all across except in China and a few other countries. These are way above bubble territories of the past, to a great extent driven by the AI Euphoria. This is concerning as long term profit margins of companies tend to be in a range and a vary high MarketCap to GDP indicates that investors in general believe that profits will be higher than they were historically which normally does not actually play out.
The current month will be important as stock markets have done well over the last quarter and we are yet to see the company results and those need to support the market movement. Today as we stand the Nifty is up 20% for this year and was up 20% last year also. The Small and Midcap Indices are up much more and nearly double of the large cap indices. This makes it an even bigger ask from the smaller companies. Recent data suggests that SME companies are trading at valuations of 65X PE ratio nearly double of the mainboard smallcap indices which also reflects extreme euphoria.
At the domestic level one key development which has now become concerning is the growing trend of populism among state government’s ,especially those going to polls. This will put State Government finances into deep stress and reduce their ability to carry on investing in infrastructure and development and is s trend we need to track closely. While at the central level even with the populist schemes the strong growth in tax collections and reduction in leakages has kept the fiscal position strong the same cannot be said for the states. The other big concern is also the huge flow of IPO’s at very high valuations as well as from Private Equity companies and promoters of companies. The question we need to ask is that if promoters are selling so much and think that their companies are more than fairly valued then what is the view that minority shareholders should take.
On the positive side the rate cycle has clearly peaked and interest rates should come down over the next two years. Monsoons have been very strong and while they create supply disruptions in the near term as we go into the months of November and December we should see food inflation plummet significantly. In the CPI that is the only component which needs to come down now. Consumer demand has now been subdued for nearly 2 years and a revival there is imminent. The government continues to focus on investments in renewable energy, defence and is driving many investments via PLI schemes and this could continue to be supportive of growth at one level while there seems to be a bubble building on the Solar panels and cell investments front where the supply build up is so huge that we could see huge oversupply in three years time.
In a nutshell we are entering and interesting month of October where stock markets need to justify they moves they have made. The result season will be keenly watched. I would like to be cautious without being bearish and maintain a cash level of 12-15% in general and conservative investors can hold somewhat more. If markets do not correct and valuations move higher then we could increase cash but this is a fair level at this stage. I do not think there is going to be a market crash however a correction at some stage is imminent and as that happens it will give opportunities to value investors to buy stocks cheaper.
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