Markets shaping up for a sharp upmove

After a sharp correction in the month of January and the first week of February we have seen markets stabilize and have been trading in a narrow range over the last few days. There have been a number of news flows affecting the markets the prominent among which is the crisis in the PIGS countries (i.e. Poland , Ireland Greece and Spain ), more specifically in Greece. Recently concerns on inflation have built up and news flow on the withdrawal of stimulus both monetary and fiscal have also affected the markets. Large redemption’s from emerging market ETF’s and also hedge fund shorting of such ETF’s have also led to the markets coming off. As against an inflow of around USD 64 billion into these funds last year the last 6-8 weeks have seen redemption’s to the tune of around USD 15 billion.
On the other hand we have also seen that economic numbers have been improving sharply and specifically in India we have seen IIP data being very strong and is expected to remain strong over the next few months. Both India and China have taken the liquidity withdrawal route for reducing the money float with the intention of sucking out cheap money which can be used for speculation and can lead to the growth of asset bubbles. These actions have been taken by the respective Central Banks after analyzing the growth prospects and being confident about a sustainable economic recovery. Economic numbers coming out of the US as well as Japan have been positive with European countries still not showing much of growth traction.

Growing risk aversion as well as the crisis in the European Union have led to the US Dollar appreciating sharply and the US Dollar Index has moved up to levels of 81.50, an appreciation of nearly 10% over the last three months.(Incidentally making the US Treasuries as one of the best performing asset classes). The US markets have also outperformed most emerging markets by a substantial margin since the beginning of the year 2010 as money has flown back into the US as part of the short term reversal of the Dollar Carry Trade.
The increase in the discount rate for emergency loans by the US Fed on Thursday let to emerging markets selling off sharply on Friday. However I believe this was a positive action as it is an indication by the Fed that they view the emergency period as being over and the markets are now back to normalcy.

At this point of time the markets are more focused on the concerns however the US Dollar Index has now gone into heavily overbought territory and the redemption pressure from ETF’s and other emerging market funds seems to be easing off. Markets in India in particular and most global markets are trading near the levels seen in June/July 2009 and as such have spent nearly 7-8 months consolidating after the sharp upmove seen after the March 2009 bottom. My guess is that the markets are now coming to the end of the range bound trading period.

Not withstanding the fact that markets can be volatile running up to the Union Budget and a few days after that, the overall outlook seems to have improved significantly and I expect the markets to move out of this tight range where it has spent a better part of the last 7-8 months over the next 3-4 months. There was a very interesting analysis of the uptick in inflation in developed economies by a columnist who termed it as “Slumpflation” which is essentially high inflation one year after the biggest slump period as most asset as well as commodity prices are most depressed at that time and as such one year after that due to the base impact the inflation looks high despite significant slack the economy in the form of high unemployment and low capacity utilizations.

There is today too much of a consensus on the markets being in a range and the upside happening only in the second half of the year 2010, however I believe that the breakout will happen much earlier. Cash positions among equity funds have gone up and also specifically for India as per the latest survey nearly 60% of the fund managers are underweight India. I believe that these people are too much focused on short term issues without recognizing that the growth trajectory in India has gone back to the 8-10% range which will lead to upgrades in earning growth prospects.

On an overall basis the markets are looking to give a rally of atleast 25-30% by the end of calendar 2010.

“The key to making money in stocks is not to get scared out of them” ~Peter Lynch

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