Equity strategists opened the year with predictions of the markets turning around by the second half. Given that both Europe and the US are expected to look at some form of quantitative easing, the forecast makes sense. But, nobody had bargained for a 10 per cent uptick in the benchmark index and $2 billion of foreign inflows in January alone. So, can this be called a dead cat bounce? From the look of it, yes.
Given that the period after 2004 shows a clear correlation between foreign institutional inflows and market performance, many are expecting surplus global liquidity to drive Indian markets this year too, just as it did in 2009-10. But, strategists are quick to warn it’s different this time, even as global quantitative easing is set to coincide with India’s rate easing, as was the case in 2001 (after the 9/11 attacks) and 2008 (post-Lehman crisis).
Though the rate cycle is set to reverse in India, companies may feel the pinch of high interest rates this year, too, as rate easing may not be as aggressive as in 2008-2009. Also, in 2008, the deficit was at a low of 2.7 per cent of GDP. FY12 is likely to be the fourth year of six per cent-plus deficits. So, it’s somewhat early to start playing the rate-sensitives, even if they have run up in the last month or so.
Manishi Raychaudhuri of BNP Paribas looks at the past performance of rate-sensitives after the rate cuts started. He explains, “After the rate cuts began, the classic ‘rate-sensitives’ — banks, auto, etc — didn’t outperform the market in the first three months or the second (with the exception of autos).” Typically, outperformance by rate-sensitives starts in the third quarter after the rate cuts begin.
Liquidity may be driving the market now, but will it sustain? The 2003-2010 period shows a clear link between Indian markets and dollar inflows. But, look a little beyond and you see that liquidity and market performance are not correlated. Between 1995 and 2003, the market showed no correlation between FII flows and market performance, as the earnings remained range-bound. This time, too, if the buoyancy in the market is driven by better earnings, this rally may sustain.
The market surely does not know if it’s the expectation of an earnings upgrade that’s driving the rally now. According to Morgan Stanley, “The recent relative weakness in technology, consumer staples and healthcare sectors is not mirrored in the earnings estimates. Simultaneously, the strength in financials is not backed by earnings upgrades. For other sectors, it is more a case of shares rallying off depressed levels, so there is no visible disconnect between share prices and earnings.”
