Mario Draghi is doing his best to deliver on his promise of rescuing the euro zone and the global markets have responded, as expected, with a sharp rally. Indian equities have participated enthusiastically.
Will that optimism be sustained beyond the first couple of days? In the European context, there are several things that seem worth watching. One is, of course, bond yields, especially in Spain and Italy. If yields drop through the next few sessions, the equity rally will continue.
A second European variable is much less cut-and-dried. The Germans will be debating euro stabilisation measures through the second half of the month. If the Germans go along with more liquidity for the European Union (EU), that will be a further shot in the arm for financial markets. There is a fair chance that this will happen.
On the other side of the Atlantic, the noise from the presidential campaigns is starting to get higher-pitched. The latest US jobs and factory data weren’t good, and the market responded negatively. But the calculations now are much more about how every little detail is likely to affect Mitt Romney and Barack Obama. This is too confusing to call really but it will cause market twitches.
The USD/INR rate has shown signs of some hardening but it’s come off in the past two sessions from 56-plus. The euro has also shown signs of hardening. But an easing of yields across the EU could mean that it also eases. More than relative interest rate parity comparisons, which are difficult to do, given wide variations across the EU, currency rates versus the rupee will probably depend on the attitude of foreign institutional investors (FIIs) and their net inflow or outflows.
| Current (Sep 7) | Value 14 days ago | Change % | |
| Nifty Value | 5342.1 | 5386.7 | -0.83 |
| Index PE | 17.92 | 18.07 | -0.15 |
| Index dividend yield | 1.55 | 1.54 | 0.01 |
| Index book value | 2.91 | 2.94 | -0.03 |
| USD/INR (RBI Ref rate) | 55.523 | 55.382 | -0.25 |
| FII net buys/ sales(Sep 1-7)# | 2096.8 | 9729.6 (*) | |
| DII net buys/ sales(Sep 1-7)# | -113.59 | -1600.3 (*) | |
| # Rs crore, Sep 7 provisional figures; * Aug 1-31 net buys/sales | |||
Back home in Delhi, the monsoon session of Parliament has closed out with zero in the way of constructive action. However, the end of the non-session could give the government room to move ahead on a few fronts. Incidentally, the monsoon itself will be disappointing but not as terrible as feared. Agro-production should not be as badly affected as it seemed likely two months ago.
The next thing to look out for in the way of normal business would be the Reserve Bank of India’s (RBI’s) credit policy, which is due on September 17. If there’s a rate cut – and that’s a big if – and it coincides with looser money in Europe, it will certainly boost Indian stock markets. The most likely central bank action, however, is no action at all. That’s the default situation discounted by most traders.
On the policy front, the government seems to be gearing up for follow-on disinvestments in three mining public sector undertakings (PSUs). None of these are worth buying unless the pricing is very well-managed. However, if the government is serious about selling off some stake, it might try to persuade RBI to loosen up. Or, it may take other measures like instructing LIC, State Bank of India, UTI, and so on to pump some money into the secondary market. Again, this could be a temporarily bullish factor.
The domestic institutional attitude has been consistently negative through the past three months (June-August 2012) when they’ve sold around Rs 3,300 crore net. While equity operations have been muted, they’ve also bought over Rs 110,000 crore in debt between June-August and another Rs 15,000 crore of debt in September. Overall, since September 2011, domestic institutional investors (DIIs) have increased net debt exposure by over Rs 412,000 crore, while cutting equity exposure by around Rs 10,000 crore.
This is in stark contrast to FII action. The “firangis” have bought over Rs 20,000 crore in equities between June and August, while being slightly negative (about Rs 61 crore in net sales) in debt. In the past 12 months, FIIs have bought net equity of over Rs 61,000 crore and net debt of Rs 46,000 crore. As I’ve mentioned before, there would be huge capital gains for DIIs (and some capital gains for FIIs as well) as and when RBI cuts rates. That could trigger a surprisingly strong stock market rally.
There are a couple of other things that traders may wish to consider. There is a fair chance of an increase in fuel price now that Parliament has adjourned. This could certainly be positive for the fisc and it could trigger a spike in the share prices of oil PSUs.
Also, the recommendations of the Shome Committee report are likely to be considered and may perhaps be accepted. The response to this may be more nuanced. An increase in securities transaction tax will hurt all traders. But an elimination of short-term capital gains tax could be a huge incentive for domestic operators since it means potential profit inflation of 30 per cent. The recommendations would certainly ease FII concerns since it sidesteps the thorny issues of the General Anti-Avoidance Rules and tax treaties.
Technically speaking, the market seems to be gearing up for a rally. It jumped on the “Draghi put” and the period since mid-June has seen the build-up of a positive looking price line. The market bottomed out at 4800-levels in June and since then, it’s registered a series of higher peaks and higher lows. A breakout beyond 5500 Nifty could go quite a distance.
However, the fundamentals still look dubious and there has been little cause for optimism about the real economy. The recent positive trends in the financial markets have been driven by hope and liquidity rather than by improvements in real economic indicators.
At best, the Q1 results and GDP numbers suggest that the economy may be bottoming out. A bounce in Q2 probably didn’t happen, going by anecdotal data such as the weak HSBC Purchasing Managers’ Index for India and recent vehicle sales volumes. There may be a pick up in Q3 or there may not. So, there is a pretty good case for remaining cautious and hedging any long positions with a series of deep puts.
