Most people have consistently blamed me for being excessively bullish. As things turn out I guess I was not wrong. However after the steep and virtually straight line rally of the last one month I have now started becoming wary of the markets, specially the Index and large cap stocks where the move has been too much and too fast. As such I just thought that this would be a good opportunity to reflect on some risks to the markets at this point of time.
Outstanding F&O positions – The outstanding Futures and Options position has crossed Rs 220000 Crores and is now at all time highs. The Put Call ratio of the market has also been moving up continuously reflecting excessive bullishness as Put writing is much more than call writing.
Panic Buying – My view at the beginning of September was for a 5-7% rally as against the consensus of a 5-10% fall. However as the markets broke out of the range in which they were trading over the better part of the last 12 months we have seen panic buying, specially from Foreign investors who have pumped in nearly USD 4 billion in just the month of September. Most people are using these flows to change their views and the same people who were negative one month back are expecting new highs over the next three months. However as I have always maintained that past flows should not be used to make future projections of the markets as it normally turns out to be wrong. If the flows of 2007 had been used to project markets in 2008 then the markets should have continued to rally continually. However that did not happen.
European Sovereign concerns are very much alive – The borrowing costs for countries that have debt issues have been moving up continually over the last month or so. In the recently completed auctions countries like Ireland, Portugal etc. were able to borrow easily but at a cost which was at a record spread over German Bunds. Cost of borrowing for Ireland & Portugal is well above 6% now. The real issue is not in raising money but in servicing the borrowing. Given that these economies are not recovering and also given the way the Euro has moved up (again) against the USD in the recent past the countries that have been relying on an export led recovery will again come under pressure. European debt concerns will rear their head for sure sometime over the next few months.
Oversold USD and flagging US recovery – The US dollar has fallen sharply against most currencies over the last few weeks. This has led to sharp dollar carry trade flows into risky assets over this time period. However the USD is now looking oversold and as it bounces back sometime over the next few weeks we will see a sell off in risky assets. The US recovery is also expected to stall as the fiscal incentives run out over the next two months and no signs of a further stimulus. The Fed has also run out of options of using monetary policy to accelerate economic activity.
Stubborn inflation – Inflation has been very stubborn despite good monsoons and the crude oil prices being subdued. There has been a sharp rally in lot of agri commodities globally although India is thankfully insulated due to good monsoons and good expected production. However there are commodities like Cotton, Coffee, Rubber etc which have been rallying continually and have been percolating down to consumer prices. Although my view has been that inflation should start falling off sharply from now on, its actual movement will need to be monitored. Given the sharp recovery in the domestic economy the producers have got strong pricing power and any input price increases are quickly passed on. This will make the task of RBI difficult and any further tightening can lead to a deceleration of economic growth.
High Trade and Current account deficits – Due to the strong performance of the domestic economy and poor performance of export destinations the Trade gap has been increasing at an alarming pace. The current account deficit in the current year will be around 3.8% which makes the country prone to sudden shifts in capital flows.
Consensus too bullish – The consensus view is too bullish after being bearish for the last one year.
However having spoken about all the risks I am of the strong view that we are in a very strong bull market. However every bull market has sharp and deep corrections and as long as we are willing to live with them its fine. I still remember interacting with an investor in January 2009. He was really panicked and wanted to shift all the money into fixed income securities. At that time my advise to him was that those who will be able to ride through the next couple of months will see such a sharp rally that not only will they recover all the money but also make lots of it. He relied on my judgement and still appreciates the same.
This is not to say that we are in that phase today or will be in that kind of phase any time in the near term. It is just to say that given India’s growth prospects it is important to play the markets over the growth cycle time frame which is over the next 5-10 years.
Overall I believe that the markets have now made a strong base at the 5400 NIFTY and 18000 SENSEX levels and these levels are unlikely to be broken over the tenure of the current bull market. Its a strong statement but is a strong intuition that I have. At the beginning of the year I had a strong view that we will see a new high this year itself. However as the markets remained in a range over a long period of time I started doubting the view. Now it seems that we could actually see that happening.
“I’ve failed over and over and over again in my life and that is why I succeed.” – Michael Jordan