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As investors try to second-guess the US Fed, corporate and election results could have a bearing on market direction
Financial markets are bracing for the tightening of US money supply as Quantitative Easing 3 (QE3) is finally tapered. Global market indices have slid through the last fortnight as investors and traders try to second-guess the US Federal Reserve.
The Nifty and Sensex have not bucked the global trend. The main Indian indices have lost over two per cent each in the past fortnight on the back of steady foreign institutional investor (FII) selling. Moderate buying by local institutions has not been enough to compensate. The dollar has also hardened against most currencies, despite the fact that the Fed is reckoned unlikely to raise policy rates until well into 2015.
Under the circumstances, it is just as well that the Reserve Bank of India (RBI) decided to keep its powder dry and maintain the status quo in terms of both policy rates and money supply. A loosening in money supply or a cut in policy rates could have been justified on the basis of the domestic inflation-growth trends. But loosening or cuts could also create pressure on the rupee and the central bank may need to defend the rupee rate.
This will be especially true if there is dollar hardening through October and November in conjunction with a rise in oil prices. Although global crude prices have been softening, a rise in crude cannot be ruled out if only due to the seasonal demand for fuel oil in northern climes. Another major import item, gold is likely to see a seasonal rise to about 75 tonnes per month from the earlier 50 tonnes. But here again, lower global prices will help to keep the trade gap and current account deficit under control.
If it hadn't been for the external situation, RBI might have been tempted to punt on a rate cut, given a less hawkish governor. Core inflation, shorn of fuel and food, has fallen in August to 6.9 per cent in terms of the consumer price index (CPI) while core inflation is at 3.5 per cent on the wholesale price index (WPI).
Overall, the WPI is down to 3.74 per cent, while the CPI is at 7.8 per cent. These inflation rates are in line with RBI's glide path and target of eight per cent CPI in January 2015. If that is met, the focus will shift to meeting the January 2016 target of six per cent. RBI has warned that the patchy monsoon performance may impact food prices.
The majority of RBI-watchers now appear to be interpreting the latest policy statement as an implicit promise to cut if the January target is met. But there is a substantial minority that suspects RBI will maintain the status quo until April 2015, even if the January 2015 CPI target is met.
The central bank also says it is cautiously optimistic about gross domestic product (GDP) growth recovery despite chances of a slowdown in Q2 and Q3. It is holding its GDP growth target at 5.5 per cent for 2014-15 with a mini-max range of five to six per cent. Many other institutions are more optimistic and most analysts concur that an acceleration of GDP growth beyond 6.5 per cent is possible in 2015-16.
The festive season could help to keep consumption ticking over. September did see automobile industry unit sales rise by a moderate seven per cent. But manufacturing seems to have slowed, with the Purchasing Managers' Index dropping to just above 50.
The market may have stopped offering a "Modi-premium" in valuations according to Morgan Stanley. The latest investment patterns are aligning to stocks with better than average growth prospects and decent financials. However, the Nifty's PE has edged up above the long-term (five-year) average of 19.5 and corrections from this level could be quite severe.
Presumably, the corporate results season, which will soon kick off, will have a bearing on market direction.
As to overseas news, Europe continues to look weak while America continues to recover, albeit more slowly than desired. The Chinese will make their GDP growth targets but they are finding it difficult to deal with the Hong Kong protests without sparking off outrage. An escalation could hurt the People's Republic of China in much the same way that Tiananmen Square did in 1989.
The concrete gains from the prime minister's US tour appear to be nebulous. It may result in easier visa processes for Indians and it will probably result in a less prickly diplomatic relationship. That is much more difficult to quantify than the $35-billion investment commitment Modi won from Japan and the $20-billion commitment that Xi Jinping offered.
On the political front, the Maharashtra Assembly elections in mid-October may be considered crucial by the ruling party at the Centre. The vote is likely to be split five-ways with the major alliances of the Bharatiya Janata Party (BJP)-Shiv Sena and Congress-Nationalist Congress Party having broken up and the Maharashtra Navnirman Sena also going it alone. The BJP must be hoping it can swing a majority in this confused scenario, or that it can be senior partner in a post-poll alliance.
Energy stocks have seen some speculative buying on the news that diesel decontrol and gas price hikes are around the corner and likely to be announced post-election. Information technology and pharma both have support due to the dollar effect.
In general, speculation has cooled off, given the uncertainties above and FIIs are likely to be either sellers, or fence-sitters until such time as the Fed's mindset is clear. Domestic sentiment will be affected one way or another by the Maharashtra election results. The market could see a further correction, coincident with a flight to safety in the form of FMCG stocks. A big rally in banks and other financial stocks might have to wait for a rate cut.
