This week in the markets: India in focus as six-week election concludes

The Indian stock market is once again the centre of attention as the Nifty 50 index hit a new record high on Monday before giving up most of the year’s gains on Tuesday. The latest volatility comes as the country’s long election process comes to an end this week. Investors initially welcomed exit polls suggesting that Narendra Modi was on course for a third consecutive term as Prime Minister. But hopes for a landslide victory were quickly recalibrated as the counting began on Tuesday and the result looked to be much closer.

Modi’s BJP party has been behind an infrastructure-led growth spurt and a set of market-friendly reforms that make him the clear investor’s favourite. So, polls suggesting that the party will achieve a two-thirds majority in India’s lower house, enabling a continuation of the recent direction of travel, helped push the market nearly 4% higher and further into record territory at the start of the week.

India’s market has been one of the top performers since the pandemic, with the Nifty 50 index rising from a low of around 8,000 to over 23,000 in the past four years.

The BJP has made its management of the economy a key feature of the long election campaign. The prospect of a landslide paved the way for even more radical reforms but the PMs room for manoeuvre is likely to be smaller if, as expected, the outcome is more finely balanced.

Last week it was announced that the Indian economy grew by a higher than expected 7.8% in the three months to March and S&P said it would be upgrading the country’s credit rating on the back of its stable policy environment and high infrastructure spending.

The surge in share prices this week follows a 1.9% fall last week as investors weighed the possibility of a smaller than expected margin of victory for Modi which the weekends polls seemed to contradict but may have been prescient. Foreign investors, in particular, spent May reducing their holdings as they assessed the sky-high valuations on which Indian shares now trade.

Although the S&P 500 is widely cited as the world’s most expensive market, thanks to the heavy weighting of high-rated tech stocks, the Indian market is actually just as pricy, trading at more than 20 times expected earnings.

India has in many ways picked up the emerging market baton from China in recent years. As China’s economy has floundered on the back of a slower than expected recovery from Covid and a debt-laden property sector, India’s growth has picked up from a lower base and now easily outpaces that of its bigger neighbour.

The Indian market is not the only one to be riding high at the moment. In a worrying sign of increasing frothiness in parts of the stock market, US penny stocks are firmly back in the sights of investors who have ridden the tech stock rally and are now looking for other higher-risk areas in which to secure big profits.

Seven of the top 10 most traded stocks in the US in May were lowly-priced, and often unprofitable, smaller companies which are characterised by high volatility, making and losing money quickly for investors.

The rise in penny share investing is an echo of the meme-stock boom in 2021 when companies like retailer GameStop and cinema chain AMC fluctuated wildly on the back of frenzied retail investor interest.

Despite the broadening out of investor interest, the so-called Magnificent Seven tech stocks remain firmly in focus. In particular, Nvidia has seen its shares continue to rally hard on the back of its recently announced better than expected first quarter results. The company is now valued at $2.7trn, up $350bn in just over a week since it reported surging revenue growth in the first three months of the year.

The sharp rise in Nvidia’s market value is partly a reflection of investor enthusiasm for its strong revenue and earnings performance. But there is a technical reason for the upswing too as growing numbers of investors are looking to lock in potential further gains by buying so-called call options which give them the right to buy shares at a pre-set price in the future.

These options, which pay off if the price continues to rise, are viewed as a cheaper way of benefiting from the rise in Nvidia shares. But the dealers who sell the options to investors are obliged to buy actual shares to hedge their exposure. This can trigger a self-fuelling cycle of option buying and further hedging of positions.

One market strategist this week called Nvidia a ‘one-way wrecking machine’, highlighting the outsized influence this one stock now has on global stock markets.

On this side of the Atlantic, Europe is in focus again this week following last week’s higher than expected inflation data in the Eurozone. That has cast some doubt on this week’s big event, the announcement of the ECB’s latest interest-rate-setting decision on Thursday. It is widely expected that the European Central Bank will go ahead with the first rate cut from a leading central bank despite the first increase in inflation this year in Europe.

Inflation emerged at 2.6% in May, up from 2.4% the prior month, the first upward move in a year which has seen price rises heading back down to the ECB’s 2% target. That in turn has encouraged the belief that the bank will cut the cost of borrowing from its current record high of 4%. Christine Lagarde, the bank’s president, has hinted that in the absence of a serious deviation from the downward trend in inflation, the ECB will be first out of the blocks with a cut this week.

That sets up a potential divergence in interest rate policy between the ECB and the Federal Reserve, which continues to sit on its hands as the US economy surprises observers with its resilience in the face of higher for longer interest rates.

The Fed keeps kicking rate cuts further down the road as it errs on the side of keeping inflation in check even at the risk of an economic slowdown later this year or in 2025. Last week the head of the Minneapolis Fed, Neel Kashkari, said he believed US interest rates should stay at their current elevated level until there was clearer evidence that inflation was under control.

He told CNBC in a televised interview that the Fed could even raise interest rates further if inflation failed to come down as expected. The Fed’s next rate-setting decision comes next week on the 12 June. Expectations of the number of rate cuts this year have been significantly scaled back and some market watchers think the Fed may even keep rates where they are until 2025.

Interest rates continue to be the most important driver of stock and bond markets. The market has risen strongly in the past 18 months on hopes that the Fed’s rapid monetary cycle would soon be reversed. Fears that rates could stay higher for longer are the biggest risk to a continuing bull market.

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Important information - investors should note that the views expressed may no longer be current and may have already been acted upon. Overseas investments will be affected by movements in currency exchange rates. Investments in emerging markets can be more volatile than other more developed markets. Reference to specific securities should not be construed as a recommendation to buy or sell these securities and is included for the purposes of illustration only. This information is not a personal recommendation for any particular investment. If you are unsure about the suitability of an investment you should speak to one of Fidelity’s advisers or an authorised financial adviser of your choice.