The road ahead for the markets

After Friday’s market sell-off, the questions on investors’ minds are: how long will the correction last? Will inflows into India equities peter out? What other factors will decide the way forward for the stock market?

The NSE’s volatility index (VIX)—the fear gauge—had spiked to the level of 18 prior to the budget, as speculation about a tax on long-term capital gains (LTCG) was rife.

In a knee-jerk reaction to the LTCG decision, domestic investors have offloaded equities worth Rs868 crore in the past two trading sessions.

This is twice the amount of equities sold by them in the month of January this year.

On the other hand, foreign investors, who have been net buyers of Indian equities since the start of this year, have been buying this month, too.

Market experts say a time and price correction was long overdue for the Indian equity markets, and LTCG was just an excuse used for the sell-off.

Sanjiv Bhasin, executive vice-president (markets and corporate affairs) at India Infoline Ltd, sees its overhang lasting for two months, and warns of another 10% correction from recent highs.

However, just like others, he remains bullish on the market from a longer-term perspective.

While the tax does not completely take the sheen off equities as an asset class, it does increase the probability of some FII money being diverted to other markets. “India is a consensus overweight among global fund managers, but post Budget and LTCG we may see money getting re-allocated to countries like China, Japan and the US, which are seeing more positive fiscal reforms,” said Ritesh Jain, chief investment officer, BNP Paribas Mutual Fund.

Another factor that could have a role to play in accelerating this correction is movement in the US bond yields. Reacting to a stronger-than-expected jobs report, the US benchmark 10-year yield rose to a four-year high of 2.85% on Friday. The Reserve Bank of India’s interest rate decision on 7 February will also be closely watched.

But whether India’s growth story remains compelling among investors will depend on many other things too. These would include inflation, which could spike due to the expansionary measures announced in the Union budget; the movement in crude oil prices—a tailwind until last year and now a key headwind; and goods and services tax (GST) revenues, which will decide the fate of the government’s fiscal position.

Domestic brokerage house Kotak Institutional Equities in a report dated 1 February said: “If GST revenues were to pick up in-line with the government’s targets and inflation come down in line with the RBI’s projections, bond yields could cool down and equity market multiples hold up. If not, bond yields may rise further and equity multiples may decline after holding out in the face of higher bond yields over the past few months.”

Apart from macros, corporate earnings have to not only catch up, but the recovery has to sustain. So far the December quarter earnings have been better than expected largely due to the lower base effect of last year. A further delay in the revival would erode India’s valuations and the premium it enjoys over its peers would narrow.livemint