The Hindu Business Line : Relief rally or return of bulls?

The market seems to be in the process of adjusting itself from a high-liquidity, easy-money, low-interest rate environment to a low-liquidity, tight-money and rising interest rate situation.

The last week was the best for the market in the last seven as the Sensex closed with a positive return of 5.23 per cent over the previous week's close. Though trading was marked by volatility, there was a hint of positive sentiment returning through a minor rally that began on Wednesday and saw the Sensex appreciate 577 points to close the week at 10,401.

The question on the minds of investors is: Does this mark a turnaround in sentiment or is it just a minor relief rally? To answer this we have to examine whether there is a material change in any of the factors that caused the fall in the market over the last month and more.

And these were:

The drying up of global liquidity with interest rates moving up across major economies,

Fears over rising inflation and interest rates in the domestic economy,

Foreign institutional investors booking profits and moving funds out of the country, and

Anxiety over valuations of commodity sector stocks following the fall in commodity prices globally.

No material change

A careful observation will suggest that none of these factors has changed in the last week. Liquidity is increasingly a cause for concern and not just global fund flows but domestic as well. The Reserve Bank of India is taking its job of inflation control very seriously and is furiously mopping up excess liquidity from the system, causing bond prices to fall and yields to rise.

Even as the market was waiting for the RBI's Quarterly Review of Monetary Policy to get an insight into its thinking, the apex bank sent a strong signal of its intent last week during its auction of gilts, when it sold a higher than expected quantum of securities and set a cut-off yield in excess of 8 per cent. This has caused some nervousness in the market as it is seen as signalling a tight monetary policy regime that could cause interest rates to increase further.

Apart from its obvious implications for the stock market, a rising interest rate regime can also harm corporate balance-sheets. Companies are closely watching the developing scenario and could, in the extreme case, even postpone their fund-raising plans.

There are also conflicting signals from the US Federal Reserve on its interest rate bias, causing anxiety across global markets. The bottomline is that nobody is clear on whether another round of rate hikes is inevitable or not when the Fed meets on June 29.

The behaviour of the FIIs the last couple of weeks does not indicate a steady pattern and, if some of their statements are any indication, they are still either under-weight or neutral on the Indian market. Commodity prices that are way off their highs are not exhibiting any signs of moving up in a hurry again. And retail investors appear to be still wary of re-entering the market as they could be sitting on book losses from investments made at peak levels of the market. Mutual funds too seem to have dried up their coffers and were seen selling along with the FIIs in the last couple of weeks. Given the above, it may be premature to conclude that the minor rally of last week is a return to form for the domestic market. So, what is the near-term prognosis then?

Range-bound near-term

The market seems to be in the process of adjusting itself from a high-liquidity, easy-money, low-interest rate environment to a low-liquidity, tight-money and rising interest rate situation. The precipitous fall from its peak valuation was caused by the realisation of this change in environment and much of those fears appear to have been already discounted.

The fizz has been taken off valuations following the exit of speculative, cheap money that originally headed towards emerging economies such as ours, attracted by the prospect of substantial returns. It is unlikely that such money is going to return any time soon.

Therefore, valuations, hereon, will be driven more by fundamental factors such as corporate performance, economic outlook and government policy. Given this, it is likely that the market will remain range-bound in the near term. However, there could be minor rallies spurred by every bit of positive news.

One such event to watch out for will be the first quarter corporate results season that is just a couple of weeks away. Healthy earnings announcements, which are likely from the frontline companies, could provide a strong underpinning to near-term market sentiment.

A good investment strategy in the current environment would be to pick and choose the right, large-cap stocks at every fall and put them away for the medium to long term. Playing for short-term stakes is not going to be easy in this market.

More Stories on : Insight | Stock Markets | In Focus

Article E-Mail :: Comment :: Syndication :: Printer Friendly Page