Markets At $5 trillion: Why It's Time For Caution, Not Irrational Exuberance

On Tuesday (21 May), stocks listed on the Bombay Stock Exchange hit a collective valuation of $5 trillion for the first time ever. While this is certainly cause for celebration, it should also be cause for pause for retail investors.

Several reasons why.

First, and most important, we must know that this exuberance is largely because of the growing certainty that Narendra Modi will, in all likelihood, return to power on 4 June with a clear majority.

The jitters of the past few weeks have given way to relief as news from exit polls — supposedly banned from publication till the evening of 1 June — has trickled in to informed investors.

With two more phases to go, investors believe that there will be no surprises. But here’s the point: since punters invest on rumours and sell on certainty, the chances are the market will partially weaken after the results.

So one should be in no rush to harvest big gains after the results are out. Wait and watch is the best policy.

Second, while India’s economy is expected to do well this year (fiscal 2024-25), interest rates in the US are still high, and the odds of a slowdown in north America are even. This will impact many stocks, especially those dependent on exports.

When US rates are high — and they are unlikely to come down till the end of calendar 2024 — money flowing into stocks will also be cautious. US two-year Treasury stocks offer yields of nearly 4.84 per cent. Stocks may underperform till punters get wind of any imminent reduction in rates.

Third, one should stop and think when market capitalisation far exceeds GDP (gross domestic product). At a time when our GDP is yet to cross $4 trillion, our markets have shot ahead to a valuation of $5 trillion. A stable valuation would be 1:1, with market valuation at similar levels to dollar GDP.

Fourth, and this is a very important reason, we must know why stock prices in India are still high despite global uncertainties. The answer is simple: we are driving up our own stocks.

Over the last three fiscal years (2021-22 to 2023-24), mutual fund systematic investment plans (SIPs) have soared. There are now 87 million SIP accounts, and the amounts that flowed into these accounts has been of the order of nearly 5 lakh crore over the last three years (and including this April). That is $60 billion of our own money, a lot of it going into stocks.

In contrast, foreign institutional investors (FIIs) have been pulling out their money (Rs 27,911 crore in May 2024 as of date), partly because safe US treasury yields are so high.

Indians are taking their savings out of traditional avenues and putting the money in stocks and mutual funds, marking a fundamental shift in risk-taking intent over the last decade.

Stocks rise not only due to sound fundamentals, but excess liquidity. In recent years SIPs and domestic institutions have been contributing most of the liquidity. This is why the exit of FIIs has barely caused a ripple in the Sensex or NIfty.

Since it is our own money driving stocks, it is worth pondering whether this can continue forever. When the flows slow down, the markets may not hold, especially given two global wars and the possibility of global economic underperformance.

So, caution should be the watchword. Invest only those amounts that you can afford to lose.