3 risks that could derail market rally on D-Street

We are in a bull market. The Nifty50 has tripled from the March 2020 Covid low of 7511 giving excellent returns to investors. After setting new records in early 2024, the market has turned highly volatile.

More volatility is in store since there are inherent fundamental strengths that can support the market along with potential negative triggers that can pull the market sharply down.

How should investors navigate this tough terrain?

Let’s start with the positives.

1) The economy is in a sweet spot

India’s GDP growth rate has been revised up to around 7 percent for FY24. RBI’s projection is 7.3 percent. India’s growth rate is more than double the global growth rate of 2.9 percent estimated by the IMF for 2024.

More important, unlike many of our neighbours who are at the IMF for foreign exchange loans to tide over Balance of Payments stress, India is achieving this impressive growth with macroeconomic stability.

Our banking system is in the pink of health and the corporate sector is deleveraged, leaving behind the ‘twin balance sheet issue’ that plagued India’s growth in the early 2010s.

Impressive economic growth has translated into decent corporate earnings, and this is providing fundamental support to the market.

2) Domestic investors are now calling the shots

A major structural shift happening in the market is the explosive growth in the number of investors. The number of demat accounts has grown from 4.09 crores in April 2020 to 13 crores in November 2023.

The AUM of mutual funds has grown impressively from Rs 7.96 trillion in 2012 to Rs 50 trillion in December 2023.

The monthly inflows through the SIP route – this is the healthiest trend – have crossed Rs 17000 crores in November 2023. DIIs and individual investors have grown to become a formidable investor group and has become a countervailing force to the ‘hot money’ of FPIs.

This domestic money is now supporting the market when FPIs sell massively, in response to external triggers.

What are the risks?

There will always be risks in the market. At high valuations, risks are higher. The biggest risk is that valuations are lofty. It is important to keep in mind the fact that India is now the most expensive market in the world.

At 21,000 Nifty the market is trading at around 21 times FY 24 estimated earnings and around 19 times FY25 estimated earnings. It can be argued that high valuations partly reflect the confidence of investors in the India Growth Story.

But at high valuations, some negative triggers can cause a sharp correction. Which are the know risks?

1) Geopolitics is the biggest risk

Geopolitics has taken a turn for the worse. West Asia has become a major trouble spot with the Israel-Gaza war showing no signs of an immediate end.

It appears that Iran is trying to widen the theatre of the war and new hostilities have broken out between Iran and Iraq.

The Red Sea has become a trouble spot with frequent Houthi attacks on ships passing through this important international shipping route.

In a counter move the US and UK have attacked many targets in Yemen from where the Houthis operate. In brief, geopolitics have taken a turn for the worse and some misadventure can lead to terrible consequences.

2) Domestic politics is unlikely to impact the market, but…..

Domestic politics is unlikely to play spoilsport with the market. On 4th December 2023, after the state election results, the Sensex shot up by 1384 points.

The market’s verdict was that the general election would result in victory for the ruling party, thereby ensuring political stability which the market likes.

But, as British Prime Minister Harold Wilson famously said, “one week is a long time in politics,” and one can never be sure about an election outcome, which is a few months away.

If the election result springs any surprise going against what the market has already discounted, the market correction can be sharp and deep.

3) US macro data is crucial

The most significant macro data that has the potential to impact global markets is US inflation and interest rate. Fed chief Jerome Powell’s speech on December 13th triggered a sharp cut in US bond yields and a rally in global equity markets.

The 10-year US bond yield corrected from 5 percent in mid-October to 3.8 percent by the end of December. The Fed Pivot indicated three rate cuts in 2024 and the market started discounting six rate cuts.

It is important to appreciate the fact that the market has largely discounted a soft landing for the US economy and a reversal of the rate hiking cycle. The risk is that if this expectation doesn’t materialize, the market will correct.

Some geopolitical issues leading to supply shocks may reignite inflation which has come under control. The US 10-year yield has already moved up from the recent low of 3.8 percent to 4.18 percent by late January 2024. Investors should be vigilant about this risk.

To sum up, investors should remain invested in this bull market and continue with systematic investment in equity. Since return from fixed income is attractive, some partial profit booking from segments that are overvalued and moving that money to fixed income where returns are high would be a good and safe strategy.

(The author is Chief Investment Strategist, Geojit Financial Services)

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(Disclaimer: The opinions expressed in this column are that of the writer. The facts and opinions expressed here do not reflect the views of www.economictimes.com.)

Harry Byrne

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