Gujarat elections could be a double-edged sword for the market

Shishir Asthana Moneycontrol Research

On technical factors, the market is precariously poised. The Nifty is just above its psychological level of 10,000 and a break below this mark could embolden the bears. Over the last month, the index has fallen nearly 4 percent from its peak of 10,490, even as both foreign and domestic investors net bought around Rs 29,000 crore of shares between them.

Around 70 percent of the stocks in Nifty declined during November.

Analysts have been warning of frothy valuations for a while now, as stock prices are trading way above what their earnings would justify. Robust fund flows so far managed to tone down concerns over rich valuations so far. But even liquidity has its limits. The downtrend in the broader market despite strong institutional inflows means that the market now needs higher doses of liquidity to climb higher.

Adding to the problem of overvaluation is rising crude prices and the hardening bond yields.

The problem of markets being powered by liquidity alone is that fund flows—local and global—can be highly unpredictable.

A strategy report by Citi Research says that cumulative FII and DII (domestic institution investors) flows into the market reached USD 17 billion by the end of October 2017 – highest since 2010 - largely powered by a sharp momentum inflows into domestic mutual funds at USD 23 billion. FII inflows during this time totaled USD 6 billion.

For the calendar year 2017 Indian markets have been the top performing among emerging markets. Motilal Oswal points out that Indian markets gained 24 percent, the highest in the last three years, compared to 22 percent by Korea and 19 percent by Brazil in local currency terms. In dollar terms, India has delivered 31 percent returns during the same period.

In India, investors have been smitten by second line shares, with the mid-cap index jumping 33 percent during the year as compared to 24 percent for the Nifty index. However, based on a price to earnings ratio mid-cap index is trading at a premium of 62 percent over Nifty.

The above-mentioned data highlights the unique position of Indian equity markets which have moved mainly because of a sudden rush of retail money.

An important data point mentioned by Citi Research highlights the precarious levels at which Indian markets are perched. While Indian companies have been downgraded throughout the year, companies in emerging markets have shown upgrades. What this suggests is the gap between fundamentals and market price have widened where Indian markets are concerned.

Even as markets are precariously close to an important technical level what is also important is the timing when the level is being tested. The all-important state of Gujarat is going to the polls; any negative surprise will result in little respect for the level. But in case of a surprisingly positive result the same support can act as a spring board. It is time to play the options straddle strategy.

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