Markets May Witness Liquidity Fluctuations

The psychological fear of "height" is acting as a resistance to any meaningful progress past the 20,000 levels
Print Edition: August 2013

Kotak Mutual Fund CEO Sandesh Kirkire
Sensex and Nifty have declined by 3.98% and 4.57% during June. The volatility in June in the Nifty has more than doubled since December 2012. Markets seem to have again entered a phase of vertigo. The psychological fear of "height" is acting as a resistance to any meaningful progress past the 20,000 levels. For this reason, systemic cues seem to be generating a more pronounced reaction than may warrant otherwise.

The present phase of volatility in the equities and debt market was a result of sharp sell-off by FIIs in June. During the month, FIIs sold nearly $5.6 bn worth of securities in the debt market and nearly $1.8 bn in equities.

The value of the Rupee has been eroding over the past few months. This had increased the currency risk for the unhedged FII investments, necessitating liquidation and delay of investments to protect value in dollar terms. Market sentiments also got dampened by the fact that the declining Rupee makes the landed cost of imports more expensive, especially with respect to the crude oil.

Since this fuels inflation, the market is expecting a more circumspect approach by the RBI on monetary policy action.

Globally, emerging markets also took a hammering during June on high FII outflows. The US Fed statement which hinted at a possible tapering of QE3 was the reason for this turn in sentiments. The Fed purchases around $85 bn worth of debt in the US bond market to ensure liquidity and low yields.

The market perceives that if this support peters out, the risk premium would rise, and has, in fact, risen.

However, what is seemingly getting discounted is that there has been a commensurate toning up of the US economy, which seems to be on the path of recovery to pre-2007 levels. If this were to take root, US market demand and buoyant investment flows may provide a more structural, rather than a liquidity-led impetus to the global economy.

Gold as an asset class has also declined by around 17% over the last 6 months. As dollar's status as safe haven takes root this trend may deepen. With funds flowing away from gold assets, the possibility of equity and debt emerging as alternative investment destinations rises.

For the time being, the domestic equity and debt market would be driven by liquidity fluctuations on account of currency movement. From a fundamental view point, the Sensex P/E is trading below the historical average, which presents a value buying opportunity. Moreover, while the rate cuts may see some delay, yet around 50-75 bps of room for additional reduction seems possible. This might be delivered more gradually by the central bank over the coming period.

CEO, Kotak Mutual Fund

(This is a sponsored article)

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