Market Outlook-VRK100-11072011

Market Outlook

Rama Krishna Vadlamudi, HYDERABAD July 11, 2011

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When you thought the markets were poised for a breakdown, just the opposite happened. During the middle of June 2011, the sentiment on Indian equities was very weak and most of the market people expected the stock indices to go lower. But, in a matter of one week, the sentiment turned positive suddenly, following a couple of events. When I wrote the ‘Market Outlook’ almost a month ago, I suggested that market would climb down from 18,000 Sensex level to 17,000 levels. Against my expectation, the Sensex rebounded and closed at 18,858 last week.

During the first week of this month, equities staged a rebound led by inflows from Foreign Institutional Investors (FIIs) following the Government’s decision to hike prices of heavily-subsidized diesel, kerosene and LPG. Added to the positive sentiment were: the sharp decline in international crude oil prices; and the decision by the International Monetary Fund (IMF) and the European Central Bank (ECB) to give an aid of USD 170 billion (120 billion euro) to Greece to help it out of the sovereign debt crisis.

What investors ignored

Investors, rather traders, seemed to have ignored a variety of factors. The south-west monsoon seems to be weak with the India Meteorological Department (IMD) suggesting that rainfall so far is deficient in several met sub-divisions of the country. The IMD estimates that rainfall, during this kharif season, may be five per cent below the long-term average. Inflation is at elevated levels though food inflation seems to be on the bend. Food inflation is down to 7.6 per cent due to a high base effect of last year. The policy drift in India continues with the government not being able to go ahead with policy reforms.

Commodities

Commodities prices have come off their peaks in the last one month. After touching a low of $ 90 per barrel, the Nymex crude oil rebounded to 98-level before ending the week at $ 96 per barrel. The upheaval in Libya, Syria and other Middle East countries and the supply-demand gap are likely to drive crude oil prices to higher levels in the following months. Gold prices rose to $ 1,530 per ounce while silver ended the week at $ 36 per ounce. In Mumbai, gold was quoting at around Rs 22,000 per 10 gm and silver at Rs 54,200 per kg. World cotton and wheat prices have fallen 20 per cent off their recent peaks.

Global cues

The US unemployment rate rose unexpectedly in June 2011 from 9.1 per cent to 9.2 per cent. The US jobs data softened the commodities prices. The European Central Bank raised its benchmark interest rate from 1.25 per cent to 1.5 per cent for the second time this year. China raised its benchmark interest rates for the third time this year from 6.31 per cent to 6.56 per cent. Europe continues to be troubled with its sovereign debt crisis prompting Moody’s to cut Portugal’s credit rating by four notches to ‘junk’ status.

Amidst all the gloomy news, the Nikkei – Japanese benchmark stock index, crossed 10,000 last week. Interestingly, the Nikkei was at 10,000-level when tsunami hit Japan on March 11, 2011. It is expected that Japanese companies are recovering well from post-tsunami supply chain disruptions.

Foreign Flows

Foreign Institutional Investors (FIIs) have brought in USD 1.3 billion or Rs 5,700 crore in this month alone to the Indian stock markets. The total inflows from FIIs are at USD 2.7 billion or Rs 11,700 crore for this calendar year, as per SEBI data. The Indian stock prices are heavily influenced by FII flows.

As per Reserve Bank of India (RBI) data, foreign direct investment (FDI) in India has fallen by 62 per cent to $ 7.1 billion in 2010-11 from $ 18.8 billion in 2009-10. The steep fall is attributed to a variety of reasons, like, weak investment climate in India following the issues surrounding corruption which has dented country’s image among foreign investors, slow government decision making in business deals such as Vedanta Resources acquisition of Cairn India, and policy issues in government’s new exploration licensing policy (NELP).

India’s Exports and Imports

India’s exports have been growing rapidly in the last six months. Data from the commerce ministry shows that merchandise exports in June 2011 grew strongly at 46 per cent to $ 29 billion led by engineering, oil, gems & jewellery, and cotton yarn; while imports rose to $ 42 billion led by crude oil, precious metals, gems and machinery.

Current account deficit (CAD) for 2010-11 stood at $ 44.3 billion representing 2.6 per cent of India’s gross domestic product (GDP). This is much higher than the $ 38.4 billion deficit, 2.8 per cent of GDP, recorded in 2009-10.

Hauling over the coals

The draft mining bill proposed by the government spooked the stock price of Coal India. The bill proposed that Coal India should share 26 per cent of its net profit with the people affected by the project. The proposal will adversely affect the profits of Coal India in future. As a result, the stock price of Coal India nosedived by eight per cent on July 9th and closed at Rs 362 per share. The draft bill is likely to negatively impact others firms, like, NMDC and Sesa Goa, though the impact on these iron ore miners may be lesser compared to Coal India. A peculiar feature of Indian stock market, of late, has been that whenever the Government eyes a particular sector, the stocks in that particular sector are falling heavily. Markets, in general, do not like government intervention or control/regulation. Previously, the telecom sector was beaten down in a similar fashion.

Banking results

Banks were the first to announce their first quarter (April to June 2011) results heralding the start of results season, which opened on a positive note. HDFC, the country’s biggest housing company, clocked a 22 per cent rise (quarter on quarter) in net profit to Rs 1,176 crore boosted by a healthy loan growth of 22 per cent. HDFC says the demand for housing loans is strong despite rise in interest rates. Mid-sized private sector bank, IndusInd Bank has shown a good 52 per cent rise in net profit spurred by healthy growth in non-interest income and reduced interest costs.

In other developments, State Bank of India, India’s biggest lender, has raised its base rate and benchmark prime lending rate (BPLR) by 25 basis points (0.25 per cent) each to 9.5 per cent and 14.25 per cent respectively. SBI raised deposit rates also. Several banks, including ICICI Bank, IOB and Corporation Bank, have increased their lending rates in the last one month following a series of rate hikes by Reserve Bank of India.

Banking sector seems to be bogged down with large spike in bad loans prompting the finance minister, Pranab Mukherjee to direct the public sector banks to exercise due diligence in sanctioning of new loans and taking necessary steps for recovery in bad loans. It is no wonder that the stock market finds the stocks of public sector banks unattractive compared to private sector banks. Media reports suggest that SBI is planning to raise overseas debt of $ 5 billion as its biggest stakeholder, Government of India, seems to have no interest in investing in SBI through rights issue. The government is facing funds crunch as fiscal deficit’s target for the current financial year appears to be a difficult achievement.

Reserve Bank of India has imposed a penalty of Rs 25 lakh on Citibank for violating Know Your Customer (KYC) norms. Earlier this year, the foreign bank’s relationship manager reportedly duped several corporate customers. Due to the fraud, the bank’s customers had lost hundreds of crores of rupees.

Insurance

The regulator of insurance sector, Insurance Regulatory and Development Authority (IRDA) has imposed a penalty of Rs 70 lakh on SBI Life Insurance Company for violation of guidelines on group insurance policies.

Direct Cash Transfer

The Central Government is proposing to transfer subsidies, like, fertilizers, kerosene, cooking gas, and food grains worth thousands of crores, to the needy consumers directly. As per a task force, headed by Nandan Nilekani, the government will directly transfer cash to the consumers with the help of Aadhar-linked bank account. Aadhar is a unique identification number being given by the Unique Identification Authority of India (UIDAI), a government body. The UIDAI has already issued one crore Aadhar numbers in the last nine months.

What lies ahead?

The continuing uncertainties in Europe over sovereign debt will keep the prices of commodities under check. Other factors that are negative for commodities are the unexpected rise in unemployment rate in the US and rising interest rates in China and India, two of the top importers of raw materials. Even the ECB is going to raise its interest rates further in future. However, due to fundamental factors and the political unrest in the Middle East, crude oil is likely to go up.

The important stock indices around the world have rallied in the last one or two weeks. Last week, the Sensex closed at 18,858 and the Nifty at 5,661. Last week’s closing levels for world indices are: Dow Jones – 12,657; S&P 500 – 1,344; Nasdaq – 2,860; FTSE 100 – 5,991; Dax – 7,403; Hang Seng – 22,726; and Nikkei – 10,138.

In the short term, Indian stocks are looking to be in an uptrend led by strong FII inflows. The quarterly results also may give some positive surprises, especially from private sector banks, pharma, metals and consumption-oriented sectors. However, the long term trend for Indian stocks is hazy due to concerns on problems being faced by the central government, weak south-west monsoon, inflationary concerns and the possible decline in GDP going forward. Overall, these are interesting times for Indian stock markets.

Disclaimer: The author’s views are personal. The author has a vested interest in the stock markets. Before taking investment/trading decisions, consult your personal certified financial planner/adviser.