Stock Market Outlook: Stay put, stay cautious

The recent tremor in the Indian market was purely on foreign institutional investors (FIIs) pulling out money, which clearly showed how vulnerable Indian markets still are. A $1.2-billion outflow from FIIs in May (till 14 May 2015) created panic in the market.

A number of factors contributed -concerns surrounding taxation, poor corporate performance, Chinese $377-billion IPOs, rebalancing and reallocation of funds, speculations over growth coming back into Euro-Zone and concerns over US interest rates. The rising yields in the bond market, especially in the US, raised concerns of US increasing interest rates sooner than later.

This saw the 10-year US Treasury bond yield jump to 2.35 per cent, its highest levels since November 2014. The US 10-year yield has jumped nearly 70 basis points or 0.70 per cent, since its low of 1.65 per cent in February this year.

Similarly the German 10-year bond, which is considered a safe-haven and was trading close to zero, surged to 0.70 per cent. This abrupt rise has raised concerns over a bubble in the sovereign bond market.

R Venkat Subramaniam, CEO of Infina Finance, a Mumbai-based hedge fund that makes long and short calls to generate absolute returns, explains why.

All financial asset valuations are anchored around the relevant risk free rate. If the risk free rate is zero or close to zero (which is what most developed market sovereign bonds yield, barring the US) then any asset class yielding more than zero is fair game.

If and when there is a rapid move from this position (ultra low bond yields) there will be abrupt repricing of all other assets. At that point, fundamentals of that asset class will cease to matter for a brief period of time. Subramaniam feels it's important to realise that one is going to be affected by the bubble whether one is invested in sovereign bonds or not.

That would be some time away of course. At the moment, what we are witnessing is not that big move away from bond yields.

The recent fall in bond markets was just a sharp correction in an overcrowded trade. The main contributor to bubble creation in bond markets is central bank action, and that has not changed in any meaningful manner in the last few weeks.

If it starts, it is most likely to start from the US where there is some positive economic data, though not conclusive. All other developed economies are still worried about deflation and unemployment. The Bank of England last week brought down GDP estimates. Most parts of the world are still struggling for growth.

The one X-factor to keep in mind is if the bond markets lose faith in the ability of central banks to orchestrate this whole asset buying program, then we could have an unruly situation.

To sum up, one could say bond bubble - yes; scary - yes; ready to burst - not yet. To put it differently, this is just a tremor and not a quake so far.

Coming back to the Indian equity market, the weakness may continue. The only worrying factor is if FIIs continue to remove money.

If the outflow subsides then there isn't any worry for the Indian market across asset classes. Fundamentally there may not be much to worry about the Indian financial market, but if global weakness comes into effect, India will not be isolated.

The Indian market has seen sustained FII inflows into debt in the past couple of years. A weakness in the global bond market would also see outflow in the Indian debt market that so far seen an inflow of $6 billion till May 2015. Last year the bond market saw FIIs pumping in over $26 billion.

The bigger concern than the outflow is it may put pressure on the Indian rupee, which has already lost 3 per cent in the past few weeks following a small outflow.

We reiterate our view that there may be pain in the near-term as FIIs rebalance and reallocate their portfolio.

Unlike the developed markets, the worry for India is not growth but the rate of growth. Investors will have to adjust to the new reality that India may not be able to grow at a rate of 8 per cent on a sustained basis, but at 6.2-6.5 per cent.

In this circumstance, one will have to adjust return expectations. Correction is healthy for the Indian equity market, which had seen a sharp rise last year.

The key positive triggers for the Indian market in coming months are the monsoon, the Reserve Bank of India's monetary policy stance, and April-June 2015 corporate performance.