Market may see a deeper correction

MARKET WATCH

After the Friday meltdown, the correction is likely to continue into the next week. The upcoming Reserve Bank of India's (RBI) quarterly review of the credit policy and global cues, including the Bank of Japan's stance on interest rates, will determine the future course. But in the short term, the market seems to have no respite from global developments.

The Indian market paid a heavy price as it kept rising, taking everything for granted. Till Thursday, the market seemed to ignore a slowdown in corporate earnings. Investors felt that the slowdown was already discounted when the Sensex fell below the 12,500 mark on April 2.

The market felt that new shares and indices added to the futures and options (F&O) trade were driving up the open interest in derivatives to historic levels. Investors failed to understand that the market-wide leverage was on the rise.

The Sensex lost more than 600 points on April 2, when the RBI raised the cash reserve ratio. Since then, it had been rising without any meaningful correction, with foreign institutional investors (FIIs) on a buying spree.

When the Sensex first touched the 15,000 mark, FIIs argued that market valuations were lower than what they were when the market had reached the 14,000 mark for the first time last December. The Sensex journey continued uninterrupted till it reached the 15,800 level.

The buoyant mood is all because of the confidence in India's growth story. India certainly is a long-term growth story. Economic fundamentals, however, work differently when compared to market fundamentals. The Friday's fall has provided an opportunity for a correction. In that sense, the black Friday is actually a good Friday for the market.

Vibhav Kapoor, group chief investment officer, IL&FS, explains the situation thus: "The market has now entered the phase of intermediate correction and is expected to continue for the next three to five weeks."

He cites the following reasons for this. Valuations were stretched. Though corporate earnings in the first quarter showed growth of 18-20 per cent, they were largely in line with the expectations and not better.

Valuations of companies and sectors affected by the rupee appreciation were already discounted by the market earlier. Many companies are now saying that they have benefited from the rupee rise and this is reflected in their first-quarter earnings. Their valuations are still lower as the benefit is not an operational earning.

He expects the Sensex to settle between 14,500 and 14,200 points. His veiw is shared by many marketmen, who see that a deeper correction is yet to come.

The Asian markets are expected to open weak on Monday as a reaction to the US market, which slid on Friday despite the better-than-expected US economic growth data.

A day later, on Monday, the RBI will announce the quarterly review of the monetary policy. This again will be very crucial as the domestic liquidity is rising and forex reserves are also increasing fast, adding to the surplus liquidity in the market. The RBI will now have to take a call on the FII inflow.

Leading bankers expect a fall in interest rates. The RBI, meanwhile, will have to maintain a fine balance between controlling inflation and supporting growth.

On the global front, the fear of unwinding of the Yen carry trade looms large. The Bank of Japan will be meeting on August 8 to review interest rates. If it raises the rates, the selloff sentiment may spread to other markets.

The domestic mutual funds, which are sitting on a cashpile, may provide support to the market at the lower level. The fund houses have raised about $2 billion in the domestic market last month. Foreign investors generally go on a holiday in August. It seems that they may not enjoy their holiday this time around.