We believe investors should stay cautious and watchful of following five factors.
1> Bond yields
India's 10 year bond yield was hardening since the last one year which is unhealthy for stock markets, given that flows move to bonds and fixed income investments from low yielding high valuation stock markets. Difference between bond and earnings yields crossed the danger mark in February itself. However, it was ignored on account of high amount of liquidity flowed into mutual funds and HNI accounts after demonetization. To stabilize the excess liquidity, the RBI came into picture and gradually started sucking all the liquidity which could be verified from the statements of Deputy Governor of RBI Dr. Viral Acharya. In his April 2018 policy statement he said "The surplus liquidity in the system, which had built up subsequent to demonetization and FX inflows until August 2017, the surplus liquidity continued to decline over the last six months with corresponding rise in currency in circulation in the economy. RBI has been using multiple tools, primarily reverse repos and open market operations or OMO sales to absorb the surplus liquidity so as to reach the stated policy objective of neutral system liquidity." and in June 2018 "As expected, the redemption of market stabilisation securities in March, and the normalisation of bank balances have added to liquidity in April. However, higher than expected increase in currency in circulation during both April and May as well as the Reserve Bank's foreign exchange operations during this period have negated much of the system wide increase in liquidity. In other words, liquidity remained in neutral zone during March and April, even though it switched back between deficit and liquidity during several weeks." Tightening liquidity further created a complicated situation with high bond yields and rising valuation. And now markets needed a pin to burst the bubble. First pin was provided by SEBI which asked FIIs to submit their KYC documents and IL&FS busted out.
Now what is next? India's bond yields are not just the function of India's inflation and demand and supply of Indian money. It also acts to global crude and US government bond yields. Currently, amid the uncertain scenario of trade wars, rising US inflation leading to rise in US interest rates and rise in US bond yields, India's yields remain highly vulnerable. Further, any casualties in the NBFC space for India will straight a way fuel the problems further. With elections nearby, government will have least interests in market stabilization. So, first and most important thing to watch is 10 year Indian government bond yield.
2> Currency
While currency is positively related to interest rates with rates going up currency goes up, this time it's different as other things are not remaining same (reverse of Ceteris paribus). Other factors such as heavy investment outflow, widening trade deficits, rising crude prices, increasing US bond yields and trade wars are taking the Indian rupee down. It is difficult quantify the impact on the valuation of stocks in the event of currency fall, it isn't difficult to say that it would be severely bad.
3> Crude prices
While POTUS Donald Trump's "sweet talks" to Saudi Arabia about rising crude prices haven't had any impact on crude prices which are consistently hardening for last one year, we believe that India is highly vulnerable in the increasing crude prices scenario. Crude is having a lag effect on India's inflation by 6 months; we expect the pass through of it is yet to happen. Inflation will have its impact on interest rates and thereby bond yields while increase in trade deficit could affect currency, adding a serious trouble for stock markets. Therefore, closely monitor the events and developments related to crude.
4> Elections
Government and opposition parties have nothing to focus more than upcoming general election in 2019. Historically, Indian markets have recorded their highest volatility built up in the elections. Roads, infrastructure, housing and defence are the beneficiaries in the previous government's regime. All these sectors are high beta ones and may face a lot of volatility if upcoming state elections in December 2018 see any surprises. Markets are currently factoring many panics, which include panic related to elections related developments. Closely monitor this space to take right decision on right time.
5> Growth & Valuation
Nifty 50 is currently trading at 25.2x TTM EPS which is not yet at very attractive levels. However, strong expected earnings growth would help provide some base to the valuations. Further valuations adjust to growth and bond yields which currently look like on the side of bond yields. Closely monitor growth and valuation in individual stocks with stocks focused in right sectors. Attractively valued companies with sound financials would be great for long term investment.
Comments
Post a Comment