The time has come for markets to break out.
Indian markets have successfully climbed the wall of worry post-demonetisation. Economy has achieved normalisation sooner than estimated. The impact of demonetisation on corporate earnings too has been limited, as can be seen from the results of the quarter ended December 2016, wherein most of the companies have posted better-than-expected results – especially, as expectations have been low. Demonetisation has failed to affect investor sentiments and foreign investors have continued to remain positive on India. India has attracted FDI of over $35.8 billion during April-December 2016, and is expected to cross $40 billion mark in 2016-17.
NIFTY 50 has rallied sharply from 7894 on 26 December 2016 to 8896 on 17 February 2017, gaining 1000 points in less than two months. This move has come, despite serious concerns over future growth prospects post demonetisation. Despite the sharp rally of past two months, NIFTY 50 has remained flat at February 2015 levels.
There has been a sharp fall in interest rates, as RBI has cut repo rates by 175 bps since January 2014 to 6.25 per cent. The government has been successful in controlling inflation – mainly driven by the fall in commodity prices and by maintaining fiscal discipline. Even with the fall in the cost of capital, NIFTY 50 has not outperformed, as recovery of corporate earnings has been dismal. Investors are waiting for a turnaround in earnings.
In November-December 2016, NIFTY 50 failed to catch up with the global rally, as various global factors, in addition to demonetisation affected the momentum. The Dollar Index, which indicates the value of the dollar, relative to a basket of foreign currencies, strengthened sharply from 96.94 on 4 November 2016 to 103.81 on 3 January 2017. This strengthening of dollar led to high volatility in Indian markets, as foreign investors withdrew funds. The US government may not favour sharp strengthening of its currency, as that will adversely affect its growth prospects, derailing the economic recovery.
As the Dollar Index again started correcting towards 100 levels, Indian markets started recovering, resulting in a sharp rally in equities. Since 26 December 2016, the rally in NIFTY 50 was primarily driven by strong buying by DIIs, which absorbed the FII selling. Interest rates in India are close to completing its downward cycle, as is reflected from RBI’s change in stand from being accommodative to neutral, but there is still scope for the banks to cut rates. Global commodity prices have started hardening, adding to inflationary pressure. Interest rates are likely to stagnate at current levels, reducing pressure on the Indian markets in the event of interest rate hike by Federal Reserve.
Domestic investors are finding it difficult to earn good returns on their savings, as banks have aggressively cut interest rates on FDs to 6.75-7.50 per cent. Other popular asset classes, such as gold and real estate, too are not expected to generate good returns post demonetisation. With limited investment opportunities available and with expected revival in corporate earnings, a large portion of the additional domestic savings is getting channelised into equities through regular SIPs. Domestic Equity MFs are getting monthly inflows of over Rs3,000 crore through SIPs. This regular inflow of domestic savings into equities has helped in absorbing shocks from FII selling. Equity MFs have witnessed an addition of Rs55,700 crore during the April 2016-January 2017 period.
Indian corporates are shying away from making fresh investments, as existing capacities are not fully utilised. Also, they are in a clean-up mode, as the focus is on mending broken balance sheets. On the other hand, there is a credible push from the government towards spending on economically-important sectors, such as engineering, defence, roads, railways, oil & gas, mining, agriculture, etc, giving strong push to employment creation and overall economic development. Fresh inflow of orders, improved utilisations and pick-up in demand will eventually help revive corporate investments.
With 1000-point rally in NIFTY over the past few months, Indian markets may look overbought, but this rally has taken everybody by surprise. Market participants are not fully invested; nor are there any excess leverage positions. There is a flood of global as well as domestic liquidity chasing Indian markets, which will help NIFTY50 break out of its range. However, in the near term, with major events lined up in March, investors should brace for volatility. India VIX, which is quoting at 12-14, points to complacency. Adverse outcome of the state election results also may lead to panic selling in the markets, but this should be seen as an opportunity to accumulate, as the tsunami of liquidity will eventually take Indian equities to new heights.
This article was originally published in Business India Magazine.
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