Business Today

Puncture Perfect?

The Sensex fell by a massive 1,500 points from over 20,000 to under 19,000 in the short period between January 6 and 17 this year. Is the stock market rally finally coming to an end?

Dhiraj Nayyar | January 28, 2011 | Updated 16:09 IST

The benchmark BSE Sensex fell by a massive 1,500 points from over 20,000 to under 19,000 in the short period between January 6 and 17 this year. Is the stock market rally finally coming to an end?

Nirmal Jain, chairman of the IIFL Group, isn't optimistic about the outlook for the rest of the year. "Indian equities are going to face tough times for the next six to nine months." Says Sandesh Kirkire, chief executive officer, Kotak Mahindra Asset Management Company Ltd: "A future push to the markets would be driven either by strong liquidity flows or large earning upgrades. Both seem unlikely at this juncture. Markets, therefore, should move sideways over the next six to nine months giving a high single-digit or a low double-digit return." Jain agrees that the stock markets will move in a 'range bound' fashion, but in addition to liquidity and corporate earnings, he is worried about growth.

"There may be a drop in GDP growth by a percentage point because of various factors, including inflation," he says.

Sunil Kewalramani, CEO, Global Money Investor, believes that the BLIP we have seen over the last 10 days is because of the FII factor. He says, "FIIs made net purchases of stocks worth Rs 1,823.50 crore between January 3 and 5. In a sharp reversal, they made net sales of stocks worth Rs 4,419.20 crore between January 6 and 17. That pretty much explains the recent decline in the market."

Money from FIIs, of course, plays a major role in determining the fate of the stock markets. Says Mahesh Vyas, managing director and CEO, Centre for Monitoring the Indian Economy, "While the influence of FII money in the Indian stock market is small in aggregate terms, its impact is big in marginal terms, in terms of the money that actually goes in and out." Not surprisingly, FII money is described as hot money and is commonly associated with stock market volatility not just in India but in other emerging economies as well.

According to K. Vaidya Nathan, investment banker and CEO of Quantumphinance, FII flows into India will continue to be good in the foreseeable future. "With other markets (the US and Europe) not doing well, money will pour in from FIIs. This year will see more net inflow in equities than 2010 which was more than 2009. However, because the flows go in and out at short intervals, there may be volatility."

Contrary to common perception, Rajesh Chakrabarti, a professor of finance at the Indian School of Business, Hyderabad, doesn't think that FII inflows have created any bubble. "There was a fear after the US announced its QE2 measures late last year that there would be a surge of liquidity into Indian markets. That did not happen," he says. Adds Chakrabarti, "Price-earnings (PE) ratios are reasonable. The markets are neither overvalued nor undervalued. I expect them to remain in this range for the rest of the year."

Says Nathan: "Foreign flows are important but not so much to override fundamentals."

For the first time since the recovery from the impact of the global financial crisis, the fundamentals of the Indian economy are looking shaky. The latest Index of Industrial Production (IIP) statistics released for the month of November 2010 show that industrial growth had slowed down to just 2.7 per cent. At the same time, inflation was touching double digits with food inflation almost at 20 per cent. A high inflation, low growth scenario is a nightmare for any central bank. Governor D. Subbarao has said that the RBI is "desperate" to rein in inflation. That almost certainly points to an interest rate hike later this month.

Chakrabarti does not believe that a rate hike will have any short-term impact on the markets. "The markets have already factored in a rate hike," he says. The real concern is what interest rates hikes will do to corporate earnings and economic growth.

Nathan is worried about the longer term impact of higher rates on corporate balance sheets. "Higher interest rates will start to hurt Indian corporates." He also worries about what rising commodity prices will do to costs. "Commodity prices will increase even more over the next nine months. There is a lot of investor money pouring into commodity markets. Large I-banks are offering customised OTC-structured products linked to commodity prices to investors." Concludes Nathan: "With not much upside on profit margins, PE multiples will start to look expensive in the next nine months or so."

There are shades of the first half of 2008 in the first half of 2011. The Sensex then, buoyed by strong economic fundamentals and impressive foreign inflows, had scaled the peak of 20,000 for the first time in its history in January 2008, almost doubling from 10,000 in January 2007. This coincided with a more generalised global economic boom.

Like in 2011, there was a massive surge in commodity prices in the first five months of the year-the price of oil reached a high of $147 per barrel in May 2008. This sparked inflation domestically and put pressure on corporate profit margins. The RBI undertook a series of sharp hikes in interest rates over the summer of 2008 in an attempt to rein in inflation. This put additional pressure on corporate profit margins. Incredibly, even as RBI was hiking rates, the IIP for March 2008 was just 3 per cent and for May 2008 just 3.8 per cent, mirroring the high inflation, low growth scenario that is being witnessed in early 2011. All this time, the Sensex reacted to the deteriorating economic fundamentals by sliding downwards from its peak of 20,000 in January 2008 to 15,000 in July 2008.

This was well before the September 15 bankruptcy of Lehman Brothers and the onset of the global financial crisis, and so was driven more by local than international factors, an important trend to note while analysing the stock market in 2011.

In 2008, the final crash of the stock market to the 8,000 mark was driven by the collapse of Lehman Brothers and a complete loss of economic confidence globally. A crisis of that magnitude may not occur in 2011. But some are cautious. Says Nathan, "I am very bearish about the fundamentals in the US and Europe." Nandan Chakraborty, managing director, Institutional Equity Research, Enam Securities, worries about risks for the Indian stock markets irrespective of the direction that major economies in the West take in 2011. "A fresh crisis in Europe could lead to a flight to safety from emerging markets into US dollar-denominated assets. In a different scenario, a strong resurgence of US growth could see FIIs move their investments away from emerging markets to the US," he says. Kewalramani agrees: "As the US economy slowly moves from a deflationary situation to an inflationary one, there will be pressure on the US Federal Reserve to hike rates or at the very least change their language on easy money. That may lead to a reversal of FII flows from India."

There may yet be unexpected good news from the domestic political quarter. In May 2009, The Sensex recorded an increase of 2,000 points in a single day, crossing the 15,000 mark, after the UPA's comfortable election victory. Says Kewalramani, "There could be another surge in February-March if the Government presents a good budget." Others are, however, not so optimistic about its role.

Hemen Kapadia, CEO of, is wary about the impact of scams. "FIIs don't like such an atmosphere," he says. Kirkire is worried about paralysis in decision-making. "The slowdown in decision- making in the Government would affect infrastructure spends," he says.

The optimists are not deterred. Says Prateek Agrawal, vice-president and head-equity, Bharti AXA Investment Managers: "We expect 15 per cent returns in the next two-three months, 10 per cent around Diwali and 20 per cent thereafter." Says Deven Choksey, managing director, KR Choksey Securities: "It will be safe to assume that the Sensex will be above 20,000 point level by the year-end."

In January 2008, few would have forecast the outcome for December 2008 any differently.

- with Mitali Patel

Courtesy: India Today 

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