Likely normalisation of liquidity, probable surge in cost of funds pose near-term risks to markets

The current market rally has been possible, mainly due to liquidity that has been aplenty and because of low interest rates, he says. The high level of activity in the primary market may continue for some more time, a few more months.

Joseph Thomas, Head of Research, Emkay Wealth Management, feels the market has already priced in all the known factors at the upper end, receding the fears of damage likely to be caused by a third wave of COVID-19.

“Having passed through the first two waves of the pandemic, the markets seem to trust the ability of the nation to survive yet another one, with greater preparedness and universal vaccination,” he told Moneycontrol’s Sunil Shankar Matkar in an interview.

“Near-term risks come from two factors. First and foremost, the likely normalisation of liquidity and the probable surge in cost of funds,” he said. The current rally has been possible, majorly due to liquidity that has been aplenty and owing to the low interest rates.


Considering that the market is at record high levels, do you think it is not worried about a third of wave of COVID at all? Also, what are the factors the markets are factoring in, well in advance?

The markets have moved up on expectations about the future. There is a considerable amount of optimism around corporate performance and earnings growth in the coming two to three years. In fact, we have had upbeat numbers from corporates all through the last four earnings seasons. With the two waves of the pandemic almost out of our way, economic revival should gather speed, and, with it, corporate performance. The conditions for corporate performance — right from liquidity to lower interest rates — are conducive.

In the last one year, the production-linked incentive (PLI) scheme and a host of other measures have helped. Part of this exuberance is explained by the developments abroad as well, as economic revival in America and Europe is positive for our exports, technology and software services business.

So, there are enough reasons why the market is cruising along smoothly, unmindful of the occasional wind and waves. Having passed through the first two waves of the pandemic, the markets seem to trust the ability of the nation to survive yet another one, with greater preparedness and universal vaccination. The market has already priced in all known factors.

Paytm has filed its DRHP. LIC has been making preparations for filing IPO papers, and Zomato has already received a strong response from investors. Do you think the primary market will see record fund-raising in 2021 and what are the big issues lined up? What could be the amount of fund-raising?

The high level of activity in the primary market may continue for some more time, a few more months. Often the flurry of new issues follows an extremely positive sentiment and salubrious liquidity conditions and an overall positive business outlook. Generally, on an average, the funds raised in the primary market, annually, has been roughly to the tune of, say, Rs 10,000-15,000 crore. We had seen the highest level of activity in 2017 when we had almost 38 IPOs and a mobilisation of Rs 75,000 crore, followed by 2010 when mobilisation was of the order of Rs 36,000 crore.

In 2021, the amount stands at Rs 40,000 crore and 26 issues. There are many issues that are already lined up and they may add up to about Rs 20,000 crore for the next couple of months. This may take us close to the 2017 numbers. While this reflects the positive sentiment, it is often a function of anticipated business conditions and liquidity, and also, to some extent, a view of the issuer company. Glenmark Life Sciences was an important issue.

Given the rising fuel prices in India, do we really need to worry about inflation concerns, though experts feel it is transitory and not permanent?

Inflation concerns are genuine, and we need to be watchful. High commodity prices, elevated oil prices, and the weaker rupee are all things that add to the inflationary spiral. Brent Crude has pulled back to the $70 a barrel level, with the UAE and OPEC + concluding an agreement, after many days of uncertainty.

The latest CPI as well as WPI numbers, at 6.26 percent and 12.07 percent, respectively, reflect the underlying price dynamics that are emerging both in the urban and rural economy. Calling it transitory means it is going to just evaporate over a short period of time. That may prevent us from looking at enduring solutions. The adverse price level conditions may accelerate later this year because of two other factors. The sowing season has seen 15 percent lower activity, and the monsoon is reported to be almost 5 percent to 10 percent lower than the long- term average.

Domestic inflation has been felt across sectors and products, and we cannot dismiss it as a post-pandemic surge, which may pass by very soon. The problem with persistently high inflation is that it kills economic growth. It destroys demand as rising prices effectively reduces disposable incomes, which are already lower after the pandemic. Individual taxpayers have not got any tax concessions in contrast to companies.

Lower disposable incomes result in lower demand and lower growth. In an incongruent demand-supply mechanism, like it is in India, the supply-side variables may show buoyancy while the demand side may be actually deteriorating.

A lot of experts are expecting the Fed to start tapering off bond purchases towards 2021-end or the beginning of 2022. Do you agree with the statement and explain why?

In the last FOMC meeting, the potential time frame for the first hike in rates has been advanced to 2023 from 2024. In fact, some members of the policy board were of the view that the first hike could be as early as in 2022. This contains a broad indication that rates could start moving up earlier than expected and that the markets should be prepared for that. The basis for this inference is that the revival in economic growth in the US has been fantastic, and this has brought with it high inflation, too. If inflation needs to be combated, it would mean reducing the liquidity level by tapering the bond purchase programme and also by a hike in discount rate.

So, going by the rate of growth and the rate of rise in the price level, there could be normalisation sooner than anticipated. This is one side of the story. Despite all this, there is still a veil of uncertainty on the next interest rate move in the US and its timing, and also the tapering of liquidity. This is the consequence of the emergence of fresh fears of a third wave of the pandemic which is actually gaining ground in parts of Europe and even in America.

If unchecked, it could disturb the growth trajectory. This is reflected in the 10-year treasury yield, which was just a stone’s throw away from 2 percent about a month back, slumping to 1.20 percent lately. A reasonably good inference that can be made out from this is that there is quite a bit of shift into US treasuries as a move into a safer haven, and also an implied message that the threats to growth are still potent. Despite these factors pointing to the contrary, going by the historical data, one may conclude that rates may rise faster, and normalisation may set in earlier than expected, which could be early 2022.

What are the biggest risks for Indian equity markets that are trading at record high levels?

Near-term risks come from two factors. First and foremost, the likely normalisation of liquidity and the probable surge in cost of funds. The current rally has been possible majorly due to liquidity that has been aplenty and low interest rates. Normalisation usually happens in a concerted way, as it is going to happen in the US as well as the EU. The same would be true of India too.

But the market is aware that this is likely to happen, and only the timing and the quantum remain in the realm of the unknown. Inflation is above the RBI’s threshold, as of now, going by the last two month’s readings. While the Centre continues to hold growth a priority in its policy formulations, the trade-off may undergo modifications, if inflation is going to be more intense and persistent. There are reasons to believe that it may be persistent but not necessarily more intense.

The rising rates may be a challenge to the current market valuations, given the state of credit growth, and various government schemes announced in the last one year or so. A rise in rates in the US would significantly enhance the currency yield of the dollar and that may attract money into the US and US dollar-denominated assets, which, in turn, would mean that there could be exits by overseas investors from emerging markets, which, again, has implications for both market valuations and currency levels.

A second factor is the potential for a third wave of the pandemic, which cannot be ruled out at this juncture as the number of fresh cases is rising in some parts of Europe. This may slow down economies and adversely affect trade and commerce. It may be mentioned that a significant share of revenues of the Nifty companies come from exports.

One thing that sets the local economy and the markets apart is that corporate performance has been good in the last four quarters, except for Q1 of 2021, which was mainly pandemic-induced. This shows that the resilience of business and industry to sudden changes in the environment is very high. Also, the long-term benefits of various government programmes announced during the course of the last one year will accrue fully in the coming few years, and the benefits of the major tax cuts effected two years back are still with them. Therefore, even with a normalisation of liquidity or even with a limited lockdown in activity, the enduring impact of the same on the domestic economy and markets would most likely be very limited. This gives reason to be fairly optimistic about the future.

The inflows into equity mutual funds dropped significantly in June compared to May, but SIP flow remained strong. What does it indicate?

The SIP equity inflows into mutual funds have moved up in June to Rs 9,156 crore, up from Rs 8,819 crore in May. This number has remained steady and healthy all through the last 2-3 years. This is so because there is quite a significant amount of participation by retail investors through the SIP route, and this is certainly set to rise in the coming years.

This is due to the realisation that buying individual equity shares in small quantities on the stock exchanges once in a while and trying to track them all the while could be a cumbersome process, and, hence, it is better to invest in diversified equity portfolios managed by mutual funds. So, it is gradually establishing itself as the alternative route for equity market participation. Net equity flows were lower, probably due to some profit-booking at the quarter end and also lower active participation due to the developing conditions around a possible third wave of the pandemic.



Leave a Reply