A weak rupee can play spoilsport

If foreign inflows slow down, the rupee can fall further, which would adversely impact the equity markets

Followers of the “sell in May and go away” strategy would have missed out on a strong rally in the market this year. While these investors were busy vacationing, the BSE Sensex shot up over 6% in the past month. The only saving grace for them is that the move took everyone by surprise, even those who did not bother to leave their hometown.

What was surprising in the move was the lack of fundamental triggers. Fourth quarter results were mediocre with nothing much to write about. Government policies were as usual missing in action. The parliament was not allowed to function, thanks to a new set of corruption charges against the government and its interference with investigating agency Central Bureau of Investigation. There was nothing that occurred in the country that deserved a sharp rise in the market.
 
What triggered the rally was a new round of liquidity infusion in global markets, led by Japan and the US. The size of the current quantitative easing (QE) is significantly higher than all cumulative QEs that have happened since the 2008 credit crisis, says a Reliance Mutual Fund report titled ‘Assessing global liquidity and its potential impact’. At the same time, the supply of government paper and other financial instruments declined substantially. For the first time ever, says the report, there will be more supply from central banks than the supply of paper.

This time around, the flush liquidity didn’t chase expensive commodities, and instead went after equity and bonds worldwide.   Indian markets have seen an inflow of Rs 16,423 crore over the past month. Importantly, there has not been a single day in the past 30 days where FIIs were net sellers. In the month of May alone, FIIs have already pumped in Rs 10,370 crore in equities. Reliance Mutual Fund’s report says that it expects India to be the biggest beneficiary of this round of QE.

However, this inflow has found its way in select sectors. All sectors have not participated in the rally. The IT index for instance increased by only 1.4% in the past month at a time when the Sensex gained 6.35%. Similarly metals, oil and gas, PSU and consumer durable stocks did not find too many buyers.

The biggest gainers in the rally were the capital goods shares, partly on account of under-ownership and partly on account of a series of order announcements and a positive outlook given by some of the top companies. The capital goods index increased by 9.6%. Money continued to flow in the so-called defensive sectors like FMCG and health care which increased by 9.41% and 6.54%.

Lower inflation data once again raised hopes of interest rate reduction taking the banking index gain up by 7.24% and related automobiles and realty sector gain by 8.39% and 6.4% respectively.

Market commentators and analysts are confident that markets will make new highs, but one needs to keep a close watch on the FII tap. There is no denying the fact that markets have run ahead of fundamentals, and a correction, if and when it occurs, can be sharp. The indicator to fix your eye on is the rupee-dollar market. It has started showing signs of weakness, with the rupee touching a two and a half month low and going below the 55 mark. If foreign inflows slow down, then the rupee can fall further, which could adversely impact the stock market.