Why is market up even after Congress debacle in UP Election?

Congress was never expected to do handsomely in UP election. But its flat performance was little below par than expectations. And more than that, the SP performance was a surprise. Probably it teaches Congress one thing at least - how to play populism.

Inspite of all provisions of quarantined ecosystem for Budget team, it is foolish to assume that no tweaking will happen to budget provisions post the election result. Govt. is facing fiscal as well as governance deficit. Direct taxes might be spared and indirect taxes could be tinkered higher. Higher duties for diesel cars looks  very much on the cards. Higher FDI in retail, insurance looks remote.

Market has welcomed additional liquidty coming by way of surprise 75 bps CRR cut by RBI. Probably RBI will do not anything now on 15th mar and wait for directions on fiscal consolidation by FM on 16th mar. The structural issues have remained, inflation is staring up again with railways hiking rates, crude remains upwardly bound, global weather forecasters have predicted below normal monsoon rainfall. All in all, market is just reflecting short term trading speculation & parking of global liquidity in Indian markets for now.The short term up movement is also reflective of the expectations of new investments schemes at the onset of 12th five year plan.  If the budget is non-consequential, which could well be the case, we could see a dip in market levels. Inspite of the election setback, Market seems to be just living for another day, the Budget day.

Markets - Proxy to Global Trends for Now

Market upmove has continued for last 2 weeks. FIIs have bought nearly $4bn worth of equities and $3.5bn worth of debt. EPFR data suggests that the funding stems from reallocation of portfolio assets towards EM markets. The liquidity is essentially fueled by cheaper loans given by ECB to EU banks.

The Greece crisis is averted until April when Greece faces the election. The other key dates to watch for is 6^th march (UP election result), 15^th march (RBI policy review), 16^th March (Annual Budget)

The indications are that there might be CRR cuts which will ease liquidity. Budget is expected to pack in some hard measures on taxation in order to contain the ballooning fiscal deficit. If Congress wins more than 22 seats out of 403 seats in UP, it will be good for market. A credible fiscal consolidation roadmap in the budget will be good for market.

Companies are expected to report lower margins in FY12 figures in march YoY. Macro factors remain uncomfortable. Comfort from the Base effect of Inflation will run out in Mar. Domestic funds have been mostly selling since the start of 2012. So the market will remain tuned to the Global trends in short term.

RBI 50 bps hike – steep and late?

The sharp reaction by the market to RBI’s 50 basis points raise indicates that a majority of the market was caught unawares. After taking nine baby steps of 25 bps each since apr 2010, RBI suddenly decides to go ahead of the curve. RBI says that drivers for inflation now are different than they were in late last year. It was food inflation then, while it is high fuel prices and costly non-food manufacturing items now.

The argument seems odd given that crude had virtually took off with a 60 degree slope since oct last year. The commodities, which are a feeder into the manufacturing sector has long been on the boil. Since Apr 2010, Au 20%, Ag 100%, Cu 40% and Pd have risen 25%. RBI had at least three previous opportunities to rein in the headline inflation when they blamed sqaurely on supply side pressures. 

A good monsoon followed by a bumper crop output hasn’t cooled down inflation. Clearly, more than the supply chain losses, it’s the demographic pull which has not been matched by a corresponding supply infusion. This would need good CAPEX but the current RBI move will surely drive down investment even further.

The Governor further says that crude is likely to remain steep due to middle-east crisis and due to Japan situation where oil is being used as an alternative fuel owing to nuclear power shutdown.

The five regions of Japan hit by the quake contribute to about 8% of Japan’s GDP and expected to shave off at least 0.5% of GDP. So the overall slowness in economic demand should far neutralize the offtake of crude on account of power situation.

The cap on debt fund exposure is expected to release about 60,000cr of bank’s money held with the mutual funds. It will be some time before we can find out whether this money finds its way into advances to corporates OR banks use it for alternative purposes such as guarding against new NPAs arising out of higher interest regime etc. Introduction of Marginal Standing Facility (MSF) giving a corridor of 200bps [(repo + 100 bps)-reverse repo] for banks to play with, will help in easing out liquidity concerns in future.

A widening fiscal deficit should prompt the govt. to increase oil prices. A Rs 4 increase in petrol & diesel will likely push inflation up by another 0.5%. Further, IT Refunds of about Rs40,000 cr by may 2011 is analogous to an early wage hike. Govt. would have arguably benefitted by holding this fund for few more months.

US Fed’s bond buying spree is ending next month. Although Fed plans to keep reinvesting the securities, the shut down of printing machine should help in stronger dollar which usually leads to lower crude and lower commodities. The supply glut of steel, Cu, Zn in China and little monetary tightening there should further pull down the commodities given that China consumes 43% of world steel and 40% of world Cu. So from Q2 onwards, we should see some relief in prices of commodities and price of crude if North Africa situation doesn’t go beyond control.

The buzz in political circles is that Mayawati might go for an early election i.e. even before winter sets in north india. May be RBI has just done a favour to the Central Govt. with an aim to cool down prices in next 3-4 months even at the perils of growth.

The stock market will likely be now range-bound only in the short-term while the bulls enjoy their time in the shade.

Short-term bullish trend expected over May-June 2011

With Fed confirming that they are not tightening the money supply, the policy makers around the world would have to continue fighting inflationary pressures through supply side and other fiscal channels.  Fed will buy another $250bn worth of treasuries in next 2 months and EM should get their share of funds inflows. Over march and apr, India received about $3bn of inflows. Fed is going to re-invest the maturing securities means they are not going to pull back money from the system. From current inflation of 2.68%, the Fed has projected an inflation having central tendency around 1.7-2% over a medium term. So the message is not to sacrifice growth and pray that somehow inflation subsides through lower commodities prices and some political stability in oil producing nations. This would be confirmed if we see some high-intensity back-channel US diplomacy over next few weeks.

Indian market has already discounted higher oil price and a possible 25bps rate hike by RBI in its next review. The reported earnings have not been blockbuster and operating margin pressure continues although good thing is that sales growth has been by and large upwards of 25% .

So there does not seem to be any strong negative news round the block. We should see now strong buying in stocks of companies that have more internal reserves and is less dependent on the commodities sector. I expect a short-term bullish trend led by few selective counters especially in agro, consumption, pharma and banking sector.

Still a Bull market but Cautious with your picks

The RBI, in its quarterly policy review on 25^th jan, upped the inflation targets but didn’t use monetary tightening aggressively. Clearly RBI wants to signal that the supply side and system inefficiencies need to be checked than just the monetary measures.

With interest rates not rising enough, the real inflation is increasing which means that the short term FII funds might pull out and to a extent it is happening. We have seen about $1.3 bn funds moving out in 2011.

In order to bridge the apparent governance deficit, the Govt. is taking symbolic steps by arresting some of the tainted people behind 2G, CWG and other scams. But what is missing is the policy measures needed for long term sustainability of sentiments. The issues around environment, mining, land acquisition and above all the parliament deadlock continue to project vagueness and uncertainty in the minds of investors.

Private sector debt to GDP ratio is close to 0.6 now which is very high considering the past. It also indicates that there could be a lot of bad quality assets which in turn will increase the riskiness of the markets.

We see the continuing uptrend of inflation in the European region at close to 2.4% now but the interest rates are still flat at around 0.5%. The Yen has appreciated almost 10% against Re in 2010, thus eroding the gains of many Japan domociled funds. Accordingly, we are seeing a shift from equity to debt funds.

The Chinese are facing drought conditions in 7 of their provinces further driving the food prices high. China Govt. has to take steps to increase domestic consumption and curb inflation. They are sitting on reserves of $2800 bn. If Euro zone also go for a QE kind of policy, then dollar will have lesser demand and it can impact Chinese treasuries. A low growth model may actually be good for China now.

The long term US bond yields are rising, on the back of upsurge in inflation, expecting a rate increase. The Fed's purchase of govt securities have pushed enourmous liquidity into the system which is finding its way into the markets. The short term rates are almost fixed at 0 while the long term rates are rising. $ is expected to fall further against Euro. It doesn't look like Fed has much ammunition left now than to increase rates. Alternatively, deeper fiscal measures are needed to spur consumption and investment by corporate sector. Otherwise the brief recovery which is seen now will be diffcult to sustain.

We will continue to see volatility in Indian markets until budget time. The markets haven't had any good news over last couple of months. But there doesnt seem to be any structural problems. The forecast says that the monsoon is expected to be normal this year. And the problems with global crude supply seems to be checked for a short time at least.

Stocks with lesser gearing, no FCCB payouts in next 1 yr, and having some cushion to absorb 2-3% of EBITDA drop would be the good picks.

The Chinese Slowdown

China, which holds about $900 bn of US treasuries, has started buying more of short term bills and selling LT bonds in order to cut its risk on dollar volatility.
Current a/c surplus is $306 bn and capital a/c surplus is $167 bn. Together the inflows have been up 25% in 2010 YoY. The central bank raised reserve ratios six timesbut it had to raise lending rates twice, 25 bps each time to wrest inflation which is at around 5.1% now.
Clearly the quantitative maneuvring of tinkering with reserve ratios hasnt worked and PBoC will have to further increase int rates to levels of 6.5% from current 5.81%.
Years of artificial manipulation of yuan and have led to huge inflows and corresponding increase in local currency. The Chinese people household savings is at around 20% of GDP while together with govt., companies and households, the savings rate goes well above 50% of GDP. This further strengthen the export led growth paradigm. If PBoC increases rates further, yuan will appreciate which in turn will fuel domestic consumption.
The only issue is the closely guarded timings of monetary policy interventions by PBoC, which means the markets generally are not able to discount the rate impacts in advance. With China having more than 13% of World GDP of about $74 trn, such surprises affect market sentiments.