Most events over for this month, now what ?

Most of the major events scheduled for this month are now behind us with the IIP data (downside surprise), inflation (upside surprise) and the RBI policy (no surprise) getting over today. Under the circumstances the movement of the markets till the end of the month again goes back to that of following global cues. The advance tax numbers did not show any negative or positive surprise either. As such it is more important to analyze and get a hang of what’s happening globally and its impact on the Indian markets.

Globally the main theme seems to be of slowing growth with economic numbers deteriorating for the US and a number of Western countries. China reported growth numbers in line; however the impact of monetary tightening and high inflation is likely to slow down growth in China going forward. The Peoples Bank now finally seems to be acting seriously to control the genie of inflation and this has created liquidity tightness in the Chinese system. However the fixed investment binge still continues in that country and unless addressed and soft landed should lead to a hard landing at some stage.

My key call for the last two months has been for a commodity correction, which seems to be half way through at this stage. The US Dollar is looking increasingly bullish technically and could see levels of 77.5-78 in terms of the USD Index going forward. A combination of strengthening USD and slowing global growth is likely to weigh heavy on commodity prices. We have already seen crude oil prices come down to levels that are below those at the time of the start of the Libyan crisis. This is despite no resolution to Libya, simmering discontent still on in lot of Middle East countries and a failure of the OPEC talks on increasing production. This just shows the extent to which the oil market is overbought by speculators and hedge funds. A 10%, if not more correction in prices of crude is imminent. At some stage as the Libyan crisis comes to an end we could see a further sell off. Under the circumstances the projections of crude at USD 120-130 per barrel look absurd to me at this stage. Other commodities have also corrected along with crude but some of the industrial metals have not corrected in any major way and we should see that correction also unfold going forward. The Reuters CRB index looks to be completing a very negative head and shoulder pattern and technically this implies a further sharp fall of around 8-10%.

The key is that in a scenario where commodities are correcting sharply due to growth concerns, can the stock markets rally? The biggest problem that India has faced over the last 8 months has been related to inflation and its impact on growth. A fall in commodity prices will address most of the inflation concerns in India given that the monetary policy in India is formulated on the commodity focused Wholesale Price Index. However it is also observed that normally when commodities drop off sharply markets do not move up. However as the correction in commodities plays out completely over the next few weeks it will create a huge foundation for a big up move in the markets subsequently. Although it is difficult to time the duration of this corrective move in commodities, my guess is that it should be over sometime in July.

Events in Greece will also we watched closely as most people now believe that country has to default now. The impact on the markets of such an event should be limited given that it is now widely speculated. However if it happens it should impact the Eurozone more. Given the large stakes involved, my guess is that the adjustment will be done as smoothly as possible and any big write offs will not happen at this stage and will be pushed into the future.

July is also the results season and it will also provide an opportunity for investors to take a more informed call on the outperformers of the next rally. As things stand today in the markets we see the markets demarcated into two different pockets. The first is that of defensive stocks that have become institutional favorites. In case of these stocks the valuation are at a P/E of 25 to 50. On the other side is rest of the market where valuations are at 10 to 15 times for large caps and 5-10 P/E for mid caps. My guess is that as interest rate and inflation concerns peak out we will see a large number of cyclicals and growth stocks start to outperform as valuations are cheap and earning visibility will come back.

In terms of an overall view it still looks like the February/ March lows should be a good durable bottom for the markets for a strong rally into the second half of the year.