The current week was significant with the meeting of the European Central Bank and testimonies by the US FED Chairperson Janet Yellen. Fear mongering reached its zenith running into the events especially the US FED meeting in Mid December. Markets are likely to behave very differently from what people believe and here is what has happened and is likely to happen going forward.
The expectation was that the ECB will declare huge money printing and as a result of which the Euro will go towards parity to the US Dollar. As things turn out Mr. “I will do what it takes” Draghi gave a somewhat better than expected assessment of the Eurozone Economy and growth prospects than was expected. He declared that their policies are working and expanded asset buys to local and regional government debt. Overall in simplistic terms he said that we are not gonna print more money now than what we are already printing and will see what else to do in the future. This came amidst reports of improving employment and growth statistics in Eurozone. This led to an immediate rally in the Euro and a huge short trap.
On the same day Janet Yellen made a speech in which she declared that we are going to raise rates (more or less) and the global markets plummeted. The next day was another day where daily news following analysts started watching the employment data in the US. The employment data confirmed that the employment picture is strong and recovery is on. This finally led to some sense coming in the minds of traders and the US Markets not only recovered the losses of the previous day but also went higher. This was the more sensible reaction and is in line with my view that the beginning of the rate hike cycle will be extremely bullish for equities. Especially when the rate hike cycle will be shallow and gradual. Rate hikes at a time when inflation is not a big concern but growth revival is seen is going to be always bullish for risk assets.
In the meantime the RBI did not do anything in their policy which being less fearful of global factors and rightly.
The other big issues that is flummoxing domestic investors and analysts is the fact that if growth prospects are picking up in India and the outlook is strong then why are Foreign Investors selling. Everyone needs to realize that FII’s are not selling India in specific. However a general feeling of fear and unease has lead to a rapid redemption cycle where investors have pulled out a huge amount of money from both EM and Global Equity funds. This has also been contributed by the fall in oil prices and selling by oil rich country sovereign wealth funds. The question is whether this redemption cycle has peaked out. I would say that it is in the process of peaking out although SWF redemptions will continue into 2016.
The biggest factor that people should realize is that the US FED rate hike is now totally discounted by the markets. The fear of high volatility and a huge market selloff is unlikely to play out. We are most likely to see a totally reverse reaction which seems to have already started. US Dollar long is the most crowded trade today and we are likely to see a big sell off in the US Dollar after the FED meet in which they indicate very slow rate hikes going forward. The chart below shows how the USD has already peaked out and looking bearish.
We are likely to see huge outflows from bonds into equities in 2016. This is my big call and is contrary to what most analysts believe.
In the meantime domestic flows into equity continue to be strong with average flows into Equity MFs at Rs 7000-10000 Cr per month. This combined with much better FII flows in 2016 will create a strong up move in the markets.
The Indian markets now trade where they were nearly 15 months back. The positives like lower inflation and interest rates, incipient economic recovery, fiscal consolidation, revival of investments in some sectors as well as better consumer sentiments is being totally ignored. The large cap side of the market on an overall basis holds much better value at this point of time versus mid caps although mid caps always outperform during an economic upturn when interest rates are relatively benign. The start of a structural economic revival cycle will also be followed by a structural bull market.