The month of August started off with the downgrade in the Sovereign rating of the USA which led to a severe sell off in most of the global markets. There was a flight to safety and as a result of which we saw US Government Bonds, German Bunds and precious metals rally significantly. Gold prices touched all time highs during this month and ended the month up by over 12% for the month. Along with other world markets the Indian markets also fell sharply before showing a small bounce back at the end of the month. The large cap indices ended down by 9% during the month. The markets made a panic bottom in the 4th week of August and were down by 14% for the month at one point of time.
Looking forward I believe that the markets seem to have made a bottom for the current year at levels of 4700 for the Nifty and 15700 for the Sensex and this is what we had anticipated during our last review. However the pace of the bounce back in the markets will depend on several factors that include.
RBI’s policy stance – RBI has been the most hawkish central bank over the last several months and has continuously surprised markets by hiking rates more than anticipated. Twice over the last six months this move of the RBI has led to a strong build up in the markets getting stalled. The current policy rates are restrictive and have led to a slowdown in both investment and consumption demand, especially in interest rate sensitive industries. We have seen that over the last few weeks several central bankers like those of South Korea and Australia have held rates citing global concerns. There have been others like those of Brazil and Turkey that have actually cut rates citing global concerns, despite the fact that short term inflationary pressures exist in those countries. The key will be to see the stance that RBI takes. The previous policy actions of RBI have not yet fully had their impact and most contributors to inflation except for food have seen a downward pressure building up. Under the circumstances RBI now needs to be concerned about growth and hold rates. However, given the policy stance of the RBI, investors will be wary till 16th September and we are unlikely to see any sharp upmove in the markets till that point of time.
Government policy actions – Prior to the anti corruption protests starting off on 16th of August, we have seen some signs of positive policy actions being restarted by the government. However this process again went into the cold storage during the entire protest period. The key will be to see whether we see some proactive policy steps to aid economic growth coming from the government over the next few weeks. India’s premium to emerging markets has steadily come down due to a series of scams as well as the perceived lack of governance. Any positive moves on this front will be extremely important to bring stability into the markets.
Developments in the Western economies – The data flow out of the US economy has been mixed over the last few days. Although, there have been signs of stabilization of the economy, the news flow on the employment front has not been good. The key thing going forward will be to see how policy makers in the US respond to these challenges as there are two important events that will be watched this month. President Obama will lay down his initiatives to improve the employment situation and the US Fed has a two day meeting at the end of September where they are likely to respond afresh to evolving developments. With the marginal benefit of QE3 being more towards disruption and feeding inflationary pressures it will be interesting to see how they respond.
Europe also has been slow to respond to the crisis in the Euro Zone. The agreement reached to set up the stability fund and its norms of operations are still to be put into operation. This is creating further fears in the minds of investors and has led to volatility in the markets. More than the US, it is the diversity in Europe and the inability to have a cohesive response that is hurting the markets. This month will again be crucial to see the European response as fears of a credit market freeze up, like that of 2008 has been building up in the minds of investors over the last few weeks.
However, even after taking all the above concerns into account there are several indicators that are pointing towards an extremely oversold market. This includes –
-Technically the markets during this month became as oversold as they were during late 2008 and early 2009. There are large short positions and most market participants are bearish on the markets. Reuter’s polls of 57 leading investment houses in the United States, Europe ex-UK, Japan and Britain showed the average stock holding in a balanced or model portfolio falling to 49.2 percent. It is lowest since at least February 2009
Outflows from Equity funds have continued at a rapid pace with Emerging Market Funds losing nearly USD 8 billion in August, reflecting panic in the minds of investors.
Gold prices zoomed up by nearly 12% in August and gold is looking extremely overbought. Gold has now risen continuously for the last 11 years.
Specific to India trading volumes and speculative activity has come down substantially and leveraged positions on stock futures continue to be extremely low. Money has been flowing from equities to gold and bonds.
These factors combined with market valuations that are at around 12X 2013 E earnings clearly point towards a low downside risk in the markets. However an upmove is likely to take time to develop and we expect that to start from October/November as the current news flow and global events get discounted. Given global slowdown concerns, ultimately all higher growth economies will get strong inflows, however for that fear needs to reduce.
The month of September has started off constructively and we have seen an initial sign of decoupling of Indian markets from the turmoil in Europe. However it will be wrong to conclude this as a foregiven conclusion as the markets do face event risks in the near term. The good thing about the current move has been that the Nifty Futures have continued to be at a discount to the spot despite a 10% move from the bottom. This indicates that the bears are holding on while the bulls are attempting to regain charge. It will be an interesting battle over the next few weeks.With the current upmove the markets have more or less shrugged off the fall post the US Downgrade, which in my view in any case should not have had such a drastic impact.
The key event for India is the RBI policy where, hopefully the RBI will not use the current bump up in food inflation to hike rates. The sharp increase in onion and some other vegetable prices is primarily responsible for this. We have seen most central bankers (even of countries facing inflation) either hold or cut over the last one month. If RBI decides to hold we could see the rally continue, a hike could lead to another sell off as the current interest rate environment in India has become increasingly restrictive for growth.
Overall looking for 4700 for the Nifty to hold for this year and a steady upmove till the end of the year. A clearer direction will be visible after September which is a month full of events.