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On Way To Mount 45000
A decisive mandate in favour of the Modi-led NDA and a near consensus on earnings revival in FY20 are expected to drive the markets higher this year, despite global headwinds
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The general elections are over and a stable government is in place at the Centre, which is a big positive for the markets. The trend indicated by the exit polls has been confirmed by the resounding mandate to the NDA government. On 20 May, in what can be termed as a very strong and unprecedented reaction to the exit polls, the equity markets saw a gap up opening, got stronger to-wards the end and gave a fresh lifetime high at closing. Nifty ended the day with a gain of 421 points or 3.69 per cent higher. This was followed by profit taking on the day of actual results with the Nifty ending in the red by 80 points. However, in the course of the day the Sensex did touch the magic mark of 40000. The big question is: what next?
A strong and stable government is, without doubt, very positive for the markets. According to V.K Vijayakumar, Chief Investment Strategist, Geojit Financial Services, “there is every reason to remain bullish on India. The economy is strong enough to overcome the short-term headwinds and cruise towards sustained long-term growth, which will take the market to much higher levels.” Some analysts even predict that the Sensex could climb to 45000 by the yearend. However, all has not been not hunky-dory for the markets. The year 2019 began on a grim note with the markets going down on fears of continuation of rate hikes by the US Fed. However, the scenario changed after US Federal Open Market Committee (FOMC) at its January 30 meet kept the rates unchanged and declared that it was putting further rate hikes on hold. What it changed was the capital flow situation. Later, the ECB also came up with a dovish monetary stance. The dovish stance of the two leading central banks of the world along with monetary stimulus being implemented by the People’s Bank of China unleashed plenty of liquidity for chasing assets in the emerging markets equity. It was primarily global liquidity chasing the stocks that pushed the markets up by almost 8 per cent.
Says Vijayakumar, “At that time, it was liquidity driven tactical trade that took the markets into the bull orbit,” adding, “And this ‘risk on’ rally triggered by the liquidity flows has fuelled a global bull rally.” Going by the indices, by March end, the MSCI All Coun-try Index was up nearly 12 per cent and MSCI Equity Market Index 9.50 per cent for the year.
MSCI Emerging Markets Index was up 9.50 per cent, while MSCI India Index was up 5.71 per cent only. This means we have some more catch up to do. After the sustained outflows witnessed from India in 2018, FPI inflows have turned robust in 2019 with year-to-date inflows of more than Rs 46,000 crore.
Milan Vaishnav of Gemstone Equity Research & Advisory Services says that market has reacted in an expected way to the election results. “Historically, it (rally) does not last for a long time. Once this reaction settles, the macroeconomic, global and macro tech-nical factors usually tend to take over and affect the market more than anything else,” he says.
Markets After Previous Elections
Markets have reacted violently to election outcomes on previous occasions. However, the effect has not lasted beyond a month. If we analyze the behavior of the headline index Nifty after the 2014 election, it has enjoyed a steady up-move. However, it is very important to note that by the time the markets entered the election zone in 2014, it was already grappling with multi-month lows and was attempting to bottom out. This time, the case is exactly the opposite, as we deal with multi-month highs and that too with evident bearish divergences on important lead indicators. If we refer to two earlier general elections of 2009 and 2004, on both occasions the Nifty had reacted to the outcome with a lower circuit and the trading had to be suspended intraday into the cooling period.
Markets are known to react hyper-sensitively to election outcomes, particularly when the outcome is at variance with market ex-pectations. In 2004 when the Vajpayee-led NDA lost unexpectedly, the market crashed immediately, but recovered soon after when the reform-oriented Manmohan Singh government assumed charge with a market-friendly P. Chidambaram as finance min-ister. Again in 2009, when the UPA won without the support of the Left, the market gave a thumps-up to the “game changing election outcome.” The market can be wrong in its anticipation, knee-jerk reaction and short-term assessment of election outcomes.
Long-term prospects (Nifty chart 2)
A look at the 20-year long-term monthly chart of the Nifty throws up deeper insights and show important warning signs (see chart on Nifty). After a serious drawdown in 2008, the Nifty begin its secular upmove which first halted in 2018 for a very brief time. Beginning 2018 and until today, the Nifty has been marking incremental highs on a month-on-month basis but all the up-move during last 16 months has come with a serious bearish divergence of RSI against the price.
Relative Strength Index (RSI) is a lead indicator. This means that price follows the behavior pattern of the RSI. It can be seen that the Nifty is making higher highs.
Real reasons for markets to grow
The outcome of the general election will influence the markets only in the short term. According to Vijayakumar, “The long-term prospects for the market will not be altered by the short to medium-term reactions of the market.” It is important to note that in the long run, economic growth and corporate earnings drive the markets. Vijayakumar points out that the government’s economic policy and reform initiatives are important; “but equally important, sometimes more so, is the external economic environment”. He says with a benign external economic environment, even a lackluster government can deliver superior returns. The UPA-I is a case in point. “The Indian economy and markets benefitted from the global economic boom of 2004-08 even in the absence of worthwhile economic reforms,” he says. The most important factor driving the market after elections would be earnings growth. And, there is very good news here. There is a near consensus that FY20 earnings growth will be above 20 per cent.
After tepid performance of the last four years, the Nifty earnings are likely to see a spurt in FY20 led by corporate banks. This earnings spurt will bring the valuations into fair territory. Therefore, since the elections have thrown up a market-friendly government, it will be bullish times for the market.
According to a Mirae Asset report, earnings revival will take centre-stage to handle noises. It is believed that the earnings revival will be the most important driver for the markets during CY2019, despite global and local events. As per consensus estimate, net profit of the Nifty 50 index is estimated to grow at 26 per cent in CY20, according to the report.
The report also expects supportive macroeconomic conditions in CY2019: low inflation, manageable CAD and continued strong GDP growth at 7.3 per cent for FY2020.
The fall in crude oil prices is a boon for India as it will soon lead to current account surplus. With inflation under check, the rate of interest is expected to remain benign in 2019. India’s growth momentum is expected to improve to about 7.3 per cent in FY20 from 6.7 per cent in FY18. According to the Mirae Asset report, even the valuations are reasonable.
A note of caution
But Vaishnav has a contrarian and cautious view on the growth prospects of the markets. There are more than one factors that force him to take such a cautious view on the markets going ahead. He discounts the fact that the favorable general election outcome can cause more than 3-5 per cent potential upsides in the markets. Beyond this, at the macro level, he says, there are several important factors that warrant attention.
The inversion of US bond yield curve, the Brent crude trading at 2019 high, volatile and depreciating rupee against the US dollar, the strength in the US Dollar Index and sharp rise of Indian VIX along with the Nifty can be major causes of concern. The inversion of US bond yield curve is something that cannot be ignored. On one hand, we have historical data that quantitative easing by central banks have done little good to stimulate the economy beyond a point. On the other hand, we have Federal Reserve which has, as of now, done away with the option of raising the rates any further for the rest of the year.
Importantly, despite the S&P500 and emerging markets like India continuing to rise, it is important not to forget that bond mar-kets are always more efficient than the equity markets. Over the past several decades, it has been observed that the inversion of bond yield curve has been successful in forecasting recession nine out of 10 times.
Once the yield curve gets inverted, we may not see recession the very next day. Usually the lead period between the inversion of the yield curve and actual recession can range from anywhere between five months to two years. However, this lead period would see evident slowdown across all sectors of the economy during this time. For us, growth has been a concern of late and this is something that we cannot simply ignore. We also cannot ignore the historically positive correlation between S&P500 and Indian markets and any major decline there can have effect on us sooner or later.
As for crude which presently trades at its 2019 highs, $71.70 is a crucial resistance level. Any move above the $72-mark will see Brent testing $78-80 levels.
The domestic currency has been witnessing a volatile environment of late. The zone of 68.50 and 68.80 has been an important support for the dollar. So as long as this is not taken out on the downside, the dollar will continue to strengthen. And a depreciat-ing domestic currency coupled with higher crude prices is never good for the markets over the medium term.
The volatility factor
The relationship between the headline Index and the VIX has remained historically negative. The lower levels of VIX have often been associated with important market tops. Similarly, the VIX highs are often seen when the markets are in the process of finding bottoms.
At present, this relationship has been thrown completely off-balance and the correlation between the Nifty and the VIX has grown strongly positive. Whenever this has happened in the past, barring one exception, the VIX has bought the markets down along with it over following weeks (see chart).
Mid-caps and small-caps
Irrespective of the outcome of any event in the recent future, broadly speaking, the coming two to three years will belong to a se-lective stock picker. Analysts expect the markets to turn extremely stock and sector specific in nature in coming months.
Whether small or mid-cap, the action is likely to remain limited to pockets of fundamentally sound companies. Secular broad ral-lies in mid and small caps may not happen going ahead easily. Talking of broader markets, we need to mention about the CNX500 Index which represents over 95 per cent of the free float market cap of all listed companies on the NSE. This index has a serious re-sistance in the 10000-10100 zone. Additionally, with even the hint of any corrective move, one may also see focus shifting to large cap stocks.
In a nutshell, markets certainly have upside potential due to the favorable outcome from the general elections. However, at the same time, the upsides, if there are any, remain capped beyond a point. But overall, it will be the macroeconomic factors, global factors that will make the markets touch new peaks after last year’s performance.