The Indian stock markets, along with other emerging markets and commodities, have recovered from the recent lows. However, analysts warn that the markets will face more headwinds (global and domestic) in the near future and are expected to remain volatile in the next couple of months. Go through these factors to find how they can impact the stock performance and, in turn, affect your investments.
Money flow from the US
The US Federal Reserve's quantitative easing programme (commonly known as QE2) is coming to an end on June 30. The 2010 rally in the commodities and emerging markets was largely due to funds flowing in from QE2. These markets can correct sharply if the US does not launch the next stimulus programme (QE3). Analysts are not too hopeful.
"The QE3 is unlikely unless the US economy slows much more than what the consensus is currently expecting," says yotivardhan Jaipuria, Head (India Research), Bank of America Merrill Lynch. "QE3 may not start soon because there is enough liquidity in the global market now. Japan has also pumped in liquidity after the earthquake and tsunami," says Girish Nadkarni, executive director and Head (ECM) of Avendus Capital.
The end of QE2 is likely to have a negative reaction but analysts feel that it won't be very drastic for the Indian markets. "With net FII outflows on a year to date basis, I think the risk of a market crash (Nifty crashing below 4800) due to the stoppage of QE2 is relatively limited (less than 20% probability)," says Parul Saini, Executive Director, RBS Asia Securities. "After the initial reaction, investors are going to distinguish between commodity producers and commodity users like India," says Jaipuria. A correction in commodities is likely to be good for user countries like India.
Euro debt crisis
Things are far from rosy in Greece. The 10-year bond yield has already hit 16%, double the level at the time of the first bail out. The two-year yield has crossed the 26% mark recently, a huge burden no country can afford to pay. Banks and governments are trying to prevent the Euro region's first sovereign default and the final decision is expected at a summit on June 23-24.
While everyone agrees that Greece needs another bail out, other nations are not that forthcoming now, especially to solutions that impose additional cost on their taxpayers. The other option is a planned default, which will create turmoil across the globe. Moody's Investors Service has downgraded Greece's debt from B1 to Caa1, putting it on a par with Cuba, and raised Greece's risk of default to 50%. Any default by Greece will pull down all risky assets such as stocks in emerging markets, including India.
Though it has subsided a bit, there is a possibility of another wave of unrest hitting new nations once there is a regime change either in Libya or in Yemen. If the strife spreads to other oil producing countries, it will push up oil prices further.
Importing countries like India will be the worst affected. The crisis has forced the region's other rulers to spend tens of billions of dollars to redress public grievances. To cover these additional costs, energy producers have to squeeze more money from their oil fields. This means raising their break-even price, the money they must make from each barrel of oil, to avoid fiscal deficits.
Producers' rising break-even points also have profound implications for major oil importing countries like India. That explains why most analysts are expecting the oil to remain at these elevated levels in future. Can it spike from current levels again? Yes, but only for short term, because it will affect the global growth.
"High oil prices and global recovery can't happen together, one has to give in," says Nadkarni. "From a medium to long term perspective, it is in the interests of oil producers to ensure that supply shocks don't have a significant impact on global growth, as that would lead to lower demand for oil in the future," explains Sukumar Rajah, managing director and CIO, Asian equities, Franklin Templeton Investments.
With some stability coming to the markets, investors have started assuming that everything is fine and the same is getting reflected in the CBOE Volatility Index. The index, which is also referred to as the global fears index, is close to its four-year low. That means, any of the events mentioned above can spike the risk aversion, sending the commodities and emerging markets into a tailspin.
Apart from these global factors, there are also some domestic factors at work. Though the Indian stock market ignored the lower than expected GDP growth rate for Jan-Mar 2011 period, economists warn about more growth pain in the coming quarters. "The sub-8% GDP growth is expected to continue in the first half of fiscal year 2012," says Rohini Malkani, economist, Citi India.
"With higher rates, increasing oil prices, and the impact on capex, we expect the GDP growth to slow further to 7.5% in 2011-12," says Tushar Poddar, Chief India Economist, Goldman Sachs. The data for the April-June quarter is also showing a weakening trend.
The HSBC- Markit purchase manager's index (PMI) fell from 58 in April to 57.5 in May, lowest level since it hit 56.8 in January. A reading above 50 indicates expansion while anything below it implies contraction. The wholesale auto numbers for the month of May also show a slowdown in growth.
Rising interest rates
Stock market shrugged off the lower than expected GDP numbers, because of the hope that lesser growth may force RBI not to go for the next hike in the upcoming policy review meeting.
However, economists still believe that RBI will continue with its rate hikes. "Even though economic activity is slowing, we think that inflationary pressures will keep the RBI in a tightening mode and we continue to expect a 25 basis point rate hike on June 16," says Poddar. The general consensus is that the RBI will hike rates by another 75 basis points (including the 25 basis point rate hike expected on June 16).
As explained in our May 23 issue, stock analysts are also aggressively reducing their earnings estimate for the next financial year. For example, the consensus earnings estimate for the Sensex in 2011-12 came down further to Rs 1,243.70 (compared to Rs 1,255 on May 20) and the same is expected to fall further to Rs 1,200 levels in the coming months.
Should investors bother about the earnings downgrades and rising interest rates because the market's one-year forward P/E is close to its long-term average? Yes. "In a period of earnings downgrades and rising rates, there is a tendency for the market to go below the historical average multiples," says Jaipuria.
The monsoon hit the Indian mainland on May 29, two days ahead of its schedule on June 1 and the stock market has responded well to it by notching good returns since then. However, there are worries that pre-monsoon showers cooling the interiors can affect the wind patterns and, therefore, can affect the spread of monsoon, especially to the interior region. This fear explains why most analysts predicting the 2011-12 GDP growth have set a good monsoon as a pre-condition.
"Our 8.1% 2011-12 GDP estimates rests on normal monsoons and an investment pick-up. A less than favourable monsoon could result in agri growth being flat over 2010-11 levels and consequently bring down the headline GDP to 7.6%," says Rohini Malkani, Economist, Citi India.
What you should do
Stay in cash: Since the market is expected to remain volatile in the coming months, the best strategy is to increase the cash level in the portfolio.
Stick to large-caps: Restrict investments to large-cap-dedicated mutual fund schemes. These will not be as volatile as mid-cap schemes.
Invest gradually: Make sure you don't invest all your surplus at one go just because the market slips one day. The interest rate-sensitive sectors like real estate, financial services, auto, etc have a significant weight in the major indices like the Sensex and the Nifty and will exert pressure on them.
Buy defensive sectors: Restrict investments to defensive sectors like FMCG, pharma, etc
Avoid interest rate sensitives: Stay away from interest sensitive sectors like real estate, banking and auto. They are expected to be under pressure till the inflation and interest rate hike cycles peak out.
Source: Economic Times
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