The month of September started off peacefully and then the markets took a turn for the better post the takeover of the RBI’s helm by Raghuram Rajan and subsequently the postponement of Tapering by the US Federal Reserve. At the time of the FED euphoria I had warned that the euphoria seems to be a bit premature as the drama of the US Politician was yet to play out and the way the things were panning out it seemed very likely that this event would create volatility in the markets going forward and as I write this article this event is playing out. The markets were also taken by surprise by the increase in Repo rate by Raghuram Rajan in his first monetary policy. Why the markets were so surprised actually surprised me as I had pointed out right when he was appointed that the first step that he would take is to increase the policy rate while reversing the retrograde measures that Subbarao had introduced. Subbarao’s panic reaction of taking the effective policy rates up straight from 7.25% to 10.25% created a situation where it created more of a market disruption rather than bring any stability to the Indian Rupee.
As we start the month of October and the last quarter of the year 2013 I believe that the events to be watched and some things that could play out will be as follows.
Volatility will increase – I believe that the volatility in various asset classes is likely to increase in the last quarter of the year due to various events that are happening globally. The global economy clearly seems to be on the mend with the growth numbers in general as well as sentiment indicators surprising on the upside across various economies. This increasingly creates a situation where ultra loose monetary policies will need to be wound up slowly and steadily. The markets will need to adapt to this. However one thing seems to be becoming clearer, the US Budget impasse along with the fight on the US Government debt ceiling creates a situation where the US economy will get impacted on the downside. This increases the possibility that the FED Tapering will get delayed. The second big money printer has been the Bank of Japan. With improving growth signals in Japan the government out there has increased sales tax in order to improve its fiscal position. This will in turn mean a prolonged ultra loose monetary policy by the BOJ and continued money printing. As such funds flow globally should remain strong. Given the strong performance of various developed markets for the year 2013 some profit booking could come up in these markets during the last quarter thus creating volatility.
Gold & Silver are turning increasingly bearish – I have been bearish on gold and silver prices for a long time. The prices have come down substantially in US Dollar terms. The prices of silver are down substantially in INR terms also, however gold prices have not come down that much mainly due to two reasons. The first is obviously the fall in the value of the rupee which has pushed prices up in INR terms and the second has been the increase in import duties in phases from 2% to the current 10%. It has also been my expectation that we are likely to see a final capitulation in gold and silver prices over the next three quarters. Recent price behaviour is reinforcing this belief and now it seems that it is possible that we see a decline of 15% in gold prices and 30% in silver prices over a short period of the next few weeks.
Crude Oil dynamics are increasingly turning bearish – The Demand/Supply balance of crude oil has been bearish for some time over the last couple of years. Increased oil production in the US combined with subdued demand globally has kept a lid on crude oil prices. Ideally the prices should have come down but the political unrest in the Middle East countries combined with some supply disruptions have kept prices higher. However two significant developments have happened in the last one month. The first has been international agreement on handling the Syria issue and the second more important event has been the changed position of Iran with regards to engaging with the West. Now this event is very significant for oil prices. Logically if Iran comes back into the mainstream over the next one year and Iran oil production moves up this will create pressure on oil prices both due to increasing supply and also a reduction in risk premium on crude oil which could be as much as $ 10 per barrel. This could be very positive for a country like India.
Domestic economic data could start improving – Despite interest rates in the economy continuing to be high and a lack of investment confidence we are slowly seeing some signs of economic revival. The core industries data for September shows some recovery, the pickup in bank credit indicates some sort of growth revival and the impact of a good monsoon will be seen on the economy going forward. Government expenditure growth has been strong and aiding economic growth. Some of the governments initiatives on clearing already awarded or stuck projects will also show some impact on growth. This could have been much better, however dysfunctional relationships between various government departments, especially the environment ministry is dragging growth. The fall in the Indian Rupee has also created a huge competitive advantage for Indian exporters which will also start reflecting in numbers. The other factor obviously will be the start of low base period of last year because of which even incremental improvements will lead to stronger headline numbers. Improving data will protect the downside of the markets.
Investors will start looking at the post election scenario – Increasingly long term investors into India will start looking at the post election scenario where some momentum seems to be building for the BJP with the huge public response to Narendra Modi. If this response gets carried on to the Assembly elections in December then we could start seeing a build up towards a positive post election scenario.
INR will stabilize with an upward bias – We seem to have seen the worst of the trade numbers and the Current Account Deficit. The trade deficit for the second and third quarters will trend down. The swap window for forex flows opened by the RBI will see strong flows over the next two months. The trend of INR should be toward the 60 levels versus the USD. The important thing will be to see that the RBI comes in to stop excessive appreciation and use the appreciation bias to build the foreign exchange reserves. High inflation in India has largely been due to the weak currency and high food inflation. Both could work positively over the next few weeks.
MARKETS
Most equity strategists are predicting a sharp decline in the markets over the next few weeks. This is not because of any great analysis but just an extrapolation of the last 25 years average trend where 17 out of 25 years have been negative for the markets in October. In reality the corrections created by various international uncertainties should be a buying opportunity. Any correction beyond 5% will create a good entry level for investors. Despite all the negatives the Indian markets are just down 2% for the year 2013 till date. The Market Capitalization to GDP has come near levels of 60% from a peak of 150% plus in 2007. As the cycle of profit compression peaks out and that of growth and profit expansion starts we will see this percentage move up. The phase of range bound markets should not last for too long now.