Market outlook subsequent to the post Budget Rally

As expected markets have rallied sharply post the Union Budget and are up by nearly 6% from the day of the presentation of the Budget. There have been several factors that have driven the markets up. The first and foremost off course was the extremely low expectation from the event and the fact that the actual delivery was much better than most peoples expectations. The fact that the government has focused on both growth and fiscal consolidation is a big positive. This has also led to huge money flow from foreign investors over the last 10 days with nearly USD 2 billion being pumped in over a short period of two weeks.

The news flow from the global markets have also been positive with the Greece market shooting up by nearly 15% over the last few days with reducing default concerns and clear signals from major EU economies on supporting Greece. Similarly with crude oil prices moving up and stabilizing upwards of USD 80 per barrel the concerns related to Dubai have also reduced as higher revenues for Abu Dhabi will eventually lead to greater probability of higher support for the Dubai region.

We have also seen the rally of the US Dollar stall and with the news flow from the Euro Zone stabilizing we should have a pull back move in the Euro to at least the 1.40 levels. The risk aversion trade that had built up due to the rally in the USD seems to be coming around now with greater allocations to risky assets.

In terms of economic news flow things continue to improve sharply in India with the strong revival in consumption seen over the last few months now also giving way to a revival in investment demand. Bank Credit growth which had come down to as low as 10% on a YOY basis a couple of months back is now at 16%. Most bankers expect credit growth to average 20-25% next year. Hiring is back in a big way in India with current estimates of one million new jobs being created in the organized sector over the next one year. This combined with salary hikes on an average of 8-10% and also strong bonus payouts after the end of the financial year on 31st March should be supportive of consumption remaining strong. There has also been a sharp correction in food prices across the board over the last two months which should lead to the headline inflation starting to soften over the next three months.

In terms of domestic funds flow into the equity markets it is estimated that the domestic insurance industry will pump in close to USD 12-15 billion dollars over the next 12 months. Flows into Mutual Funds, PMSes etc. have been muted over the last one year and have shown some signs of revival over the last two months. I expect that flows into such products should be in the region of USD 6-8 billion over the next 12 months. Besides this investors would obviously invest directly into the markets the magnitude of which is difficult to estimate.

In my trips to meet investors over the last one month I have found most investors heavily underweight on equities with large allocation towards fixed income products. The fact that most investors have missed the equity rally is also leading them to allocate higher towards real estate, which might be a good idea in the long run but from an asset allocation perspective equity seems to be very low at this stage. As the markets stabilize at higher levels, or give some correction the flows should improve as the liquidity with investors is at very elevated levels.

There have been two broad consensuses over the last one month; pre budget the consensus was that the markets will sell off in a big way after the budget and that will be a good time to buy. The correction has not materialized. The second consensus that is there today is that markets will remain in a range for a prolonged period of time. I personally do not subscribe to that view at this stage and I believe that the markets will breakout on the upside earlier than what most people estimate.

In terms of market segments the mid cap side should now start to do well as the event risk is behind us and most investors were wary of getting into mid caps prior to the budget.

In terms of risks to the markets I see two risks that are local in nature. The first is the risk of sucking out of liquidity due to highly priced issuances of Government companies. This becomes a risk at typically these are large issues and if investors do not end up making money in these the money gets stuck and the rotation in the markets go down. This also has an adverse impact on the sentiments in the markets as typically for retail investors government companies are safe investments. The second big risk I see is in the excessive speculation in new listings, specifically of small cap companies with no track record of being a listed company and as such insufficient information with investors. Typically most new IPOs of such companies are getting listed at huge premiums to the issue price with huge volumes. The valuations of most of these companies are difficult to justify and end up being at a huge premium to comparable companies which have been listed for a long time. Such stocks again will get lot of retail investors to buy into them due to the past performance and can also lead to investors getting trapped at higher prices.

However on an overall basis the market outlook continues to remain constructive and large cap, high index weightage sectors like Oil &Gas, Financials and Capital Goods look well positioned to outperform.

“We have two classes of forecasters: Those who don’t know and those who don’t know they don’t know.”-John Kenneth Galbraith. (The pun is on me too)