Fireworks on D Street: Caution advised

It is festival time on Dalal Street: Sensex and Nifty are within striking distance of 'Lifetime peaks', hopefully the targets would be achieved in next few sessions. Where do the markets go from here? Retail investors are a bit confused about the future of the markets. The euphoria may last for a while on the back of excess liquidity available with FIIs. Majority of the analysts are now advising investors to enter the equity markets. But it is advisable to be cautious at these levels, as the risk reward ratio for investors has turned negative, at least for the short to medium term (i.e. next 3-6 months).

 

Investors are advised to closely watch the underlying indicators:

• Economic indicators: The IIP numbers and Inflation index will play a major part in deciding the future of markets. IIP numbers continue to stagnate, barring a few sectors like mining. The consumer confidence index is still lying low, as would be indicated by the slow pace of festival buying by consumers. However, rural demand is showing some signs of revival. But inflation continues to climb steadily on the back of higher food prices. The situation is unlikely to improve in the next few months, forcing RBI to pursue a hawkish interest rate regime. A sustained market recovery is not possible in such a scenario.
• QE tapering: The main reason for excessive liquidity finding its way into Indian equity markets is the decision by the Federal Reserve to postpone QE tapering. This has strengthened the Indian Rupee against the US dollar, lending stability to our Forex management. However, the threat to our currency is not completely over till such time there is a sustained revival in industrial activity to accelerate our export growth.
• Market volatility: Investors are advised to keep a watch on the Nifty Vix. After consistently hovering in the 20-30 range during the past month or so, Nifty Vix has closed at 18.39 today. The market is likely to turn volatile once again if the Vix moves above the 20 levels. The result season is still not over, and the coming month would witness Q2 numbers from weak corporates putting pressure on the Vix.

In such circumstances, investors are advised to exercise caution, and refrain from putting big money into the markets, as the threat of a reasonable correction are extremely high after the initial euphoria. Most large cap stocks are now in an overbought zone, investors may look for value in select mid-cap stocks after analysing their Q2 results. Otherwise, it's time to book profits and ensure yourself a decent Diwali bonus.



Real Estate Bubble: Myth and Reality

The real estate market in India has witnessed crazy heights because its vested interests have carefully planted the idea that property prices can never go down. The real estate boom has been fuelled by acute shortage of housing, easy availability of credit and the increasing velocity of unaccounted money. There has been a marked shift in investor preference for holding real assets (real estate, gold etc.) over financial assets such as stocks and bonds. This has been supported by continuous high inflation leading to negative real returns on bank fixed deposits.

 

Between 2001-2013 real estate has proven to be the best asset class having given an average return of 600% (Some markets like Delhi-NCR or Mumbai may have given much higher returns). At the same time rental yields have plummeted to as low as 2.5%, which is much lower as compared to developed countries such as US and Japan. Real estate prices in India are the most expensive in the world based on the per capita income of various countries. Real estate prices in India have been in a bubble zone for quite some time, but they can continue to be driven by 'irrational exuberance' for some more time due to the excess liquidity in the markets.

 

However, the following factors would lead to deflation of the 'Real Estate bubble' sooner than expected:

• End of Easy Monetary Policy: The US Federal reserve is committed to roll back QE measures in a phased manner. Excess liquidity has been used to fuel real estate prices rather than funding of industrial projects. India is faced with a huge CAD (current account deficit) forcing RBI to take excessive measures to discourage investment in Gold and real estate. This liquidity squeeze may prove lethal for real estate sector.
• Flight of PE (Private equity) from Realty sector: FDI funding of Indian real estate began in 2005. Lack of transparency in the sector has seen blatant misuse of FDI being diverted to buy new land parcels rather than funding the on-going projects. This has resulted in high leveraging on the books of most real estate companies. Rupee depreciation is playing havoc with the foreign investors who are inclined to move some money out fearing instability in the currency market.
• Flight of Un-accounted money: The real estate market has been artificially propped up by un-accounted money, using the 'Chain financing' theory. Builders announce a pre-launch price to attract such funds, and allow them to offload this inventory by inflating the prices at the time of commercial launch of the project. This theory relies on the principle that it is always easy to find a bigger fool in this market. But this game is about to end now as the difference between 'new launch' and 'resale' market has widened too much. Moreover, the upcoming elections would see the flight of un-accounted money from the real estate sector as elections in India are largely funded by this un-accounted money.
• Lack of Affordability: Over the years the affordability factor in real estate market in India has taken a hit. There is a dearth of end users or genuine buyers in the market. The speculators who have been holding on to their real estate would resort to 'distress selling' as inventory levels rise further. Currently, inventory levels (unsold inventory) in 2 major hi-end markets have reached very high levels: Mumbai has inventory levels of 48 months and Delhi-NCR 31 months against the acceptable levels of 14-15 months.

The myth that reality prices can only move upwards has been shattered, as the data released by NHB revealing that prices have corrected by 1.5-3% in the April-June quarter of 2013. The real price correction is much higher if freebies offered by builders are taken into account. The pressure on real estate prices will only escalate in the days to come. Only those builders offering 'affordable housing' will be able to stay afloat as speculators flee the markets. Going by the current trend we could see a correction of anywhere between 15-30% over the next 12-18 months, followed by a period of stagnation in real estate sector for the next 2-3 years. It could be a repeat of the 1997-2001 scenario, when real estate prices saw a correction of over 40%. Real estate does not auger well from an investment point of view for the next 3-4 years. However, those willing to buy a dwelling unit for self living may have a good time 'bargain hunting'. They are advised to look for ready to move properties in the secondary market rather than opt for new launches which may not get completed on time due to liquidity crunch.