Markets in search of a direction as year-end nears

After topping 18,600 points in October, the benchmark Nifty 50 of the National Stock Exchange is now back to 17,200, the level where it was 12 weeks ago. In a statistical sense, the market has not yielded any return since August. Even so, during this 2,000-odd point, up-and-down journey of the Nifty, the outcome may have been very different for investors; the portfolio of a monthly investor in systematic investment plans (SIPs) may not have changed much, but someone who got greedy at the market’s peak and invested large amounts in mid- and small-cap companies may have lost 10-25% of investments.

Of course, 12 weeks is an extremely short, and mostly irrelevant, period to account for a return on investment in equities. Yet, it could be a useful timeframe to assess if the market is changing course.

Having quickly recovered all losses from the panic reaction to the pandemic, and moving about ~50% higher than the pre-pandemic Nifty highs of ~12,500, the equity markets appear tired and indecisive.

The indecision may be stemming from a myriad of factors. For example:*Indian markets have outperformed most global peers in the past 20 months. Global investors are now looking at underperforming markets in search of better returns. Many global brokerages have downgraded the weight of Indian equities in their portfolios to allocate more to China etc.

So, global flows to India have slowed.
- Economic growth and corporate earnings have so far failed to match the exuberance of equity markets, making the valuations of Indian equities relatively expensive, at least on conventional parameters like price-to-earnings multiples, price-to-book value and so on.
- Inflation remains a significant concern in India. Despite repeated reassurances by the Reserve Bank of India (RBI) that it is supportive of growth, market participants expect monetary tightening. Interest-rate and liquidity-sensitive sectors like financials, real estate and automobiles may be struggling due because of this.
-Many regions have recently witnessed a fresh surge in Covid-19 cases. Market participants are watching this development closely. A significant worsening. leading to fresh mobility restraints and logistic holdups, could impact the markets adversely.
- In the past few months, activity in unlisted securities which are expected to be listed for public trading in next 3-12 months has increased materially. The money invested in these securities is typically locked up till 6-12 month after the security is listed. Some active money has thus ventured out of the market.
- Global money markets are widely expected to become tighter in 2022, with many central bankers lowering stimulus. The market participants may be unsure of the likely impact of this. A stronger dollar because of Fed tightening may lead to outflows from emerging markets like India. To be sure, a growth shock in developed markets could lead to surge of flows towards emerging markets.
- Logistic constraints that have prevailed in the past 20 months are easing. Non-agri commodity prices have started to correct. The availability of semi-conductor chips that hampered manufacturing across the globe in past six months, has also started to ease now. Shipping rates are also in the process of normalizing. All this could have implications for equity markets.
Sectors like metal users, merchandise exporters, automakers that have suffered due to high commodity prices and logistic constraints, could see their operations and cost structures normalizing, whereas companies that have made exceptional gains, like metal producers, may also see their profit margins normalizing.

Once market participants are able to assess the impact of these factors on future earnings and market performance, we shall see a new leadership emerging in the markets.

For making a directional up-move, the market needs a near consensus on the new leadership, which has been lacking so far.

The directional down moves usually occur on failure of a basic premise which has been near consensus (a bubble burst, for instance); some unexpected event causing panic amongst investors (sighting of black swan); a prolonged economic recession; and/or major change in policies having a significant negative impact on a large number of existing businesses (transformational reforms). Nothing of this seems to be occurring at present.

It is more likely that market may spend some more time at the crossroads, searching for direction.