The pace and ferocity of the current rally in the stock markets is unprecedented. If one looks like a market like
If we go back to the year 2003 when the last rally started, it took the markets nearly one year to double from the bottom. The same thing has happened in just three months this time. However as a counterpoint markets also never sold off the way they did in the year 2008. Since the fall off was so sudden and sharp, the initial rally had to be sudden and sharp.
The key is that the speed of the rally is making everyone too complacent and like I mentioned earlier it has led to a phenomenon of panic buying in the markets. What I have found most surprising is the pace with which the sensex targets and stock price targets are getting revised every day. One foreign brokerage which had a target price of Rs 500 on Larsen and Toubro, post elections revised it straight to Rs 1200. Similarly I saw a report on Crompton Greaves where the target price got revised from Rs 110 to Rs 280 without any change in fundamentals. One of the most bearish brokerage houses, whose market analysts are known to be always bearish are suddenly giving a target of 19000 plus for the Sensex. It is not only amazing but it also reflects on the fact that virtually every one seems to have become a momentum player today. Integrated financial institutions who might be internally negative are giving positive views on stocks and markets in order to handle the plethora of QIP issues which are hitting the markets virtually every day.
So what will cause the markets to correct. I believe the following factors
–Cash on the sidelines has come down very very sharply over the last two to three weeks as most institutions, specially Mutual Funds and FII’s whose portfolios are declared every month end rushed to deploy a large part of their cash holdings so that their month end portfolio does not show that they have actually sat on huge cash throughout the rally from Nifty levels of 2500. Infact the average buying from mutual funds over the last few days has exceeded Rs 500 crores per day which is the highest I have seen in recent history.
–Most fund mangers on the FII side have also capitulated and deployed cash over the last few weeks. Inflows into emerging market funds which were running at over a billion dollars per week have now slowed down drastically over the last two weeks. As such a combination of low cash and low inflows should be near term negative.
– Markets have not been so overbought technically for a very long time and such overbought conditions that we see today normally will not last too long and will ultimately lead to a big sell off. The overbought nature of the markets at this point of time is similar to the markets prior to the fall in May 2006 when the markets fell off sharply before recovering in the latter part of the year. It is also similar to February 2008 when emerging markets were most oversold than ever in history.
-Increasing government bond yields globally – Government bond yields have firmed up globally over the last few weeks driven by fears of huge borrowings and high fiscal deficits. The rise in these bond yields will make interest rate declines more difficult and is likely to lead to interest rates stabilizing at levels higher than what they should have given the global economic outlook and low inflation prevailing currently. Reducing LIBOR and corporate bond spreads have hidden this phenomenon in the near term, however this is something to be watched out for
– The huge supply of paper hitting the markets – If one includes the QIP issuances announced till date combined with the IPO pipeline, nearly USD 10 billion is proposed to be raised from the markets over the next one year. This is a huge supply of paper which can not only reduce the pace of market up move but also stop it at its heel.
– Rising inflation fear – I think this is the most important factor which central bankers will have to consider going forward. Most commodities have rallied very significantly from their bottom with crude doubling in price from $ 32 to $ 65, copper rising from $ 3000 to $ 5000, palm oil rising more than 50% from its bottom etc. Similarly most agri commodities have also risen sharply from their bottom. The rise in commodity prices when the global economy is in doldrums can slow down the pace of recovery due to two factors. One is that higher spending on commodities will reduce disposable income which has as it is come down due to rising unemployment. Secondly it will lead to a rise in inflation which will lead to global central bankers to start bothering about the inflationary impact of monetary easing earlier than expected. I think this inflation scare is the biggest threat to the markets today. It can force the hands of the US Fed and ECB to start removing liquidity from the system faster than they anticipated.
I believe it is important today to stick to fundamentals and not be carried away with the market momentum. Markets always correct whenever they rise the way they have and they will correct this time also. As the rise has been a multiweek rise the fall should also be spread over several weeks.