Will Markets CRASH?

Key Concepts

• Indian Stock Market Long-Term Outlook: Concerns about premium valuation shrinking.
• FII (Foreign Institutional Investor) Activity: Shifting from net buyers to net sellers.
• Inflation-Adjusted Returns: Real returns after accounting for inflation.
• Premium Valuation: Higher valuation compared to other emerging markets.
• Time Correction vs. Price Correction: Market stagnation vs. market crash.
• Taxation Impact: Potential increase in taxes on stock market gains.
• Defensive Stocks: Stocks with lower valuations and higher safety.

Analysis of Indian Stock Market's Long-Term Outlook

Premium Valuation and FII Behavior

The speaker, PR Sundar, expresses a cautious long-term outlook on the Indian stock market. He argues that India's historical outperformance, driven by a premium valuation compared to other emerging markets (ranging from 60% to 100% higher), is likely to diminish. This premium was justified by India's high growth potential, especially post-liberalization in 1991 and accelerated in 2004.

However, Sundar suggests that India is reaching a stage of maturity, with salary and property price differences narrowing compared to other countries. He uses the analogy of a child growing to 6 feet and then not being able to grow much taller. This implies that the high growth rates that justified the premium valuation may not be sustainable.

He points to the changing behavior of FIIs as evidence. FII data shows a shift from being net buyers in most 5-year periods since 2009 to consistent net sellers in recent years. While acknowledging that FII selling in the secondary market is partially offset by primary market investments (IPOs), he emphasizes that the overall trend indicates a less favorable view of Indian markets by foreign investors.

Inflation-Adjusted Returns and Market Performance

Sundar criticizes the common practice of only looking at price increases without considering inflation. He argues that using Nifty futures, which inherently account for inflation due to rollover costs, provides a more accurate picture.

His analysis reveals that the inflation-adjusted return of the Nifty has been essentially zero for the past two years (as of February 2024). In contrast, the US S&P 500 has delivered approximately a 30% return during the same period. This significant underperformance suggests a depreciation of the Indian market's premium.

He emphasizes that this correction may manifest as a "time correction" rather than a "price correction," meaning that the market may stagnate for several years while other global markets continue to rise.

Historical Examples and Market Maturity

Sundar cautions against assuming that stock markets always rise in the long term. He presents historical examples of developed markets like the UK, Japan, and Hong Kong, as well as the emerging market of China, where markets have delivered zero or negative returns over extended periods (20+ years).

• UK Market: Zero return from 1999 to 2022.
• Hong Kong Market: Zero return from 1997 to 2022.
• Japan Market: Zero return for 25 years.
• China A50: Still trading lower than pre-Lehman Brothers collapse levels (2008) after 18 years.

These examples illustrate that market performance is not guaranteed and depends on various factors, including economic growth, money supply, and investor sentiment.

FII Selling and Government Policy

Sundar highlights the continuous selling by FIIs over the past five years and suggests that this trend may continue. He attributes this to the relatively high valuation of Indian markets compared to other emerging markets, even considering India's growth rate.

He criticizes the high valuations of many Indian stocks, particularly in the mid-cap and small-cap segments, citing examples of companies trading at extremely high P/E ratios (1000-2000) or even companies with no profits seeking high valuations.

Sundar also discusses the government's fiscal policies, noting that recent budgets have increased taxes on stock market gains (short-term and long-term capital gains, STT) and removed indexation benefits. He suggests that the government may eventually aim to tax stock market income at the same rate as regular income.

He notes that the government has been implementing small measures to attract foreign investment, such as OMO operations by the RBI and tax benefits in the budget, but these have been insufficient to counter the FII selling pressure. He suggests a "blockbuster" move, such as removing long-term capital gains tax for stocks held for a minimum of three to five years, could attract more foreign investment. However, he expresses skepticism that the government will take such proactive measures.

Investor Expectations and Market Outlook

Sundar concludes by advising investors to lower their expectations for the Indian stock market in the coming years. He cautions against investing in high P/E ratio stocks and recommends focusing on safe, defensive stocks with lower valuations.

He shares anecdotes of investors with unrealistic return expectations, such as wanting 15% per month or 40% returns through leverage in futures and options. He emphasizes that the market is unlikely to deliver such high returns consistently.

He reiterates that the long-term outlook is not very rosy and that investors should be cautious, especially in the mid-cap and small-cap segments. He suggests that the correction that started in these segments is likely to continue, at least in terms of time correction.

Conclusion

PR Sundar presents a bearish long-term outlook for the Indian stock market, primarily due to the potential shrinking of its premium valuation, continuous FII selling, and the possibility of increased taxation. He advises investors to lower their expectations, focus on defensive stocks, and be cautious about mid-cap and small-cap investments. He emphasizes the importance of considering inflation-adjusted returns and learning from historical examples of markets that have stagnated for extended periods. The key takeaway is that the Indian stock market may not deliver the high returns it has in the past, and investors should adjust their strategies accordingly.