Investors who expected 2018 to be yet another blockbuster year for stocks may have to temper their expectations. After a strong start to the year, since the beginning of February, stock markets around the world have witnessed a sharp correction. The U.S.’s decision to impose import tariffs on steel and aluminium was the latest development to infuse a sense of uncertainty. As of Tuesday, the Sensex and Nifty are marginally down since the beginning of the year. While the poor state of health of public sector banks has added to the pain, market breadth suggests a more broad-based decline. Notably, this correction comes after a record bull run that stocks enjoyed in 2017. While the Sensex advanced about 28% in 2017, the Nifty climbed 30%. Judging by the initial trading sessions of the Indian indices in March, markets look likely to keep investors on their feet. After the sharp correction in February, many expected Indian stocks to rebound to new highs, as in the case of previous corrections. But the Nifty and the Sensex, which traded sideways until Monday after their initial fall in February, resumed their short-term downtrend on Tuesday. Whether they will break lower to experience further correction or consolidate for a while before moving upwards is anyone’s guess. But it is no secret that investors have been willing to bid up the prices of Indian stocks far ahead of their fundamentals. Despite the absence of any strong rebound in corporate earnings, an underperforming economy and economic shocks such as demonetisation and the GST, investors have found enough reason to stay optimistic about Indian stocks. It is only natural that stock prices have begun to reflect, at least partially, the underlying risks.
Going forward, the biggest challenge to stock prices will be higher interest rates as central bankers move to rein in inflation amid strengthening economic growth. The U.S. Federal Reserve is expected to reduce the size of its balance sheet by $2 trillion in the next four years as it moves to let interest rates rise. Bond yields have begun to reflect the prospect of tighter liquidity. The U.S. 10-year Treasury has almost approached the 3% mark from just around 2% in September last. Many noted bond investors have confidently proclaimed the end of the multi-decade bull market in bonds, which began in the early 1980s. The Indian bond market too has witnessed a sharp increase in yields in the last few months amid fears of faster inflation as well as the government’s worsening finances. Compared to the taper tantrum of 2013, stocks have in recent times been relatively subdued in reaction to the prospect of higher interest rates. But higher interest rates are likely to eventually dampen stock prices. All this suggests that stocks may be set to experience more volatility than in the last few years.
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