Come September

As we start off on the month of September it is quite interesting that a majority of investors are negative on the markets and are looking at a 5-10% correction. The general consensus also seems to be for a Fourth quarter rally in the markets.

The current month started off on a positive note with the markets moving up and making new highs for the year in the initial part of the month. Most emerging markets held on well in spite of the extreme weakness in the developed markets, mainly driven by deteriorating economic data flow from the US. At the end the markets ended more or less flat after being up more than 4% at one point of time.

The news flow from the global markets continued to be mixed. The Chinese markets showed the maximum strength in the entire downturn and held on well. The news flow from Europe was generally positive with the economic growth numbers surprising on the upside and the fears of sovereign defaults moving to the sidelines. As Europe opens up after the vacations we will need to see how things are panning out.

The factor that negatively impacted the markets in fact came from the US where economic numbers showed signs of slackening and the employment situation continued to be grim. Today there is a peculiar situation in the US where companies are doing reasonably well and giving decent growth guidance’s. However most of the analysts are unwilling to believe that. As per the latest statistics the percentage of BUYS for stocks among analysts in the US have fallen to the low levels seen in the beginning of 2003. The funds flow picture also continued to be vastly in favor of Bonds with Bond Funds attracting record amounts of money and outflows from Equity funds continuing. In my view the government bonds of US & Germany are showing signs of being extremely overbought and seem to be heavily over owned. We have started to see the first signs of a sell off in bonds at the beginning of the month as US treasuries and Bunds have crashed over a two day period. The key is to see the trend going forward.

Most investors seem to be too focused on the amount of money that India has received since the beginning of the year and correlating it to the year 2007. However the important factor to not here is that we need to evaluate this holistically by also taking into account the total money supply globally, which has zoomed up substantially as a result of unprecedented monetary easing by central banks globally. As such the monetary base available today is several times that of the year 2007. Although the leverage in the system has reduced and the transmission mechanisms have led to a lower multiplier, still looking at the amount of money that has flown into bond funds equities still are in a phase of under allocation. Domestically also we have seen steady withdrawals from mutual funds by retail investors and despite the bull market being nearly 18 months old now there does not seem to be a conviction to put money into equities.

The economic numbers coming out of India continue to be robust although the IIP data for the month of June came out to be below expectations. With the monsoons turning out to be strong and crop acreage moving up, the agricultural growth should also contribute significantly to the overall growth numbers and also lead to a reduction of food inflation. Inflation seems to have clearly peaked out and it should fall faster than what most people expect over the next few months. The comments coming out of RBI also indicate that going forward the Monetary policy will be weighing growth and inflation prospects closely. RBI is fast moving towards neutral policy rates and any further tightening can result in a slowing down of economic activity. The GDP growth figures reported at the end of the year at 8.8% will also support this view given the fact that IIP growth has started to slow down and will need a more accommodative monetary policy.

However one specific concern for India today is the increasing trade deficit in a scenario of muted crude oil prices. This increase in deficit is due to the domestic demand being strong and the target export markets not doing very well. This does not seem to be a major concern at this point of time as other flows are very positive, however it does put India at a disadvantage in case of any external shock which leads to risk aversion and withdrawal of portfolio flows.

Most investors at this stage seem to be positioned for September to be a down month and are skeptical about the direction of the markets. Generally in the markets consensus does not work so let’s see what happens this time. Technically the position seems to be on the side of near term weakness with the probability of a further correction of 4-5%, however psychologically the consensus is too bearish for any significant correction.

Overall the medium term outlook of the markets continues to remain positive with the markets likely to rally by 10-15 % from the current levels by the end of 2010.