What next in India Equity markets?

Unwind of India euphoria premium in the absence of optimism on the way forward

Indian equity markets witnessed 3-step bull-rally since August 2013, since Raghuram Rajan took command at RBI. The first step was between August 2013 to May 2014, when NIFTY moved up from 5100 to 6600 by 30% (Bank NIFTY up from 8350 to 12800, up by over 50%). The second step was between May 2014 to mid December 2014, when Narendra Modi took charge of the new Government pushing NIFTY from 6600 to 7950 by over 20% (Bank NIFTY from 12800 to 18550 by over 45%). The third step was largely FPI driven building euphoria from Euro zone QE, RBI into rate-cut cycle, and Narendra Modi in over-drive mode on economic development and inclusive prosperity. The third step between mid December 2014 to first week of March 2015 saw NIFTY up from 7950 to 9100 by 15% and Bank NIFTY up from 18550 into 20500-21000 by over 13%.

What went wrong there? By then, RBI had delivered 2 rounds of rate cut bringing Repo rate down from 8% to 7.5%. It was seen that valuation-build from August 2013 to 1st week of March 2015 was dream come true; hence too hot to hold, against high risks from future corporate earnings not supporting the stretched valuation against high base effect coming into play. It was making sense to take profit off the table when SENSEX above 30000, NIFTY over 9100 and Bank NIFTY above 20500. It was also seen that Modi Government struggled to push through policy measures against political resistance, without enough support in the Rajya Sabha. By then, Brent Crude also regained steam with recovery by 50% from $45 to $65. Despite macroeconomic fundamentals shaping well, high valuation (not expected to be supported by corporate earnings growth) was not seen as low risk - high reward entry for fresh investments. So, given the combination of profit-booking urge and low fresh appetite at peak valuation, reversal from there was not surprise. The surprise is from the extent & speed of reversal and roller-coaster volatility between 1st week of March 2015 to now. In matter of 3 months, NIFTY unwound the mid December 2014 to 1st week of March 2015 rally for push back from 9119 to 7997 (against 19/12/14 low of 7961). Bank NIFTY suffered bigger damage for push back from 20500-21000 to 17246 (much below 19/12/14 low of 18563). Having unwound the third step euphoria rally into set cheap to acquire zone of 7965-8000 (and 17200-17350), it has been back-and-forth at 7950/8000-8465/8500 (17200/17350-18700/18850) pre & post 2nd June monetary policy review. The push-down from higher end was again after delivery of 25 bps rate cut, against downside risks on growth and inflation. The relief from post-policy low of 8056 is shallow at 8165-8190 with close now at 8114; so is BNF from 17469 to 17750-17800 with close at 17549. The complete unwind of the 3rd leg of the rally is indeed a big worry for investors and serious concerns for powers that be! All taken, the reversal was from combination of absence of tailwind support from global cues and dilution of euphoria in domestic optimism, building downside risks on growth and inflation.

More downside possible till optimism sets in by Q3/Q4 FY16

Global cues have already shifted from favourable to neutral mode, and may turn against going forward; spike in US/Euro zone Treasury yields and bearish consolidation in global equity markets are showing signs of shift to investor risk-off mode. DJI intra-2015 recovery from 17000 lost steam at resistance zone of 18350-18500 and US 10Y yield sharply up from 1.65-1.80% to 2.35-2.50%. The same is reflected in bearish consolidation in Brent Crude at $60-70 and Gold weak at 1145/1170-1210/1235 despite risk-off stance. Cash is seen to be the king in the absence of steam for early US economic recovery and mood-swings in the Euro zone over Greece and economic stability. While all these global events should ideally lead to higher appetite for India, huge opportunity loss for FPI investors since March 2015 (NIFTY down from 9000 to 8000, 10Y bond yield up from 7.60% to 8.0% against Rupee depreciation from 61.65-62.15 to 63.70-64.20) will keep there appetite neutral in wait-and-watch mode.

There are no major reasons to turn negative on domestic cues despite downward revision in FY16 GDP growth target at 7.6% (from 7.8%) and upward revision in January 2016 CPI target at 6.0% (from 5.8%). The growth pressures are largely from delay in economic capacity-build, leading to dilution in investor confidence and consumer sentiments, while inflation concerns are from suspect monsoon and lack of clarity on Brent Crude price direction within $50-85. There is better comfort on twin deficits, though.

Both combined, there are two options ahead in the short term, till end of Q3/2015. One, extended stability in NIFTY at 7965/8000-8465/8500 (Bank NIFTY at 17200/17300-18750/18850) and the other option is for extended bearish undertone at 7565/7600-8265/8300 (16150/16250-17950/18050). Both combined, near term cap is seen firm in NIFTY at 8265-8300 and Bank NIFTY at 17950-18050, break here will lead to change of outlook for bullish momentum into 8465-8500 (and 18700-18850). Beyond here, need RBI rate cut (on or before October review) to shift focus back at 8850-9150 (and 19750-20500).

What Next this week?

Retain NIFTY focus at 7965/8000-8265/8300 (Bank NIFTY at 17000/17100-17950/18050) and stay neutral on break-out either way. The best way is to play end to end with stop (and reverse) on break-out, pulling focus to either 7500-7600 (16000-16250) or 8400-8500 (18600-18850).

The external impact will be from bearish consolidation in DJIA at 17350-18350 and stability in US 10Y at 2.25-2.50/2.65% with pressure into higher end, as stakeholders await to get clarity on start of FED rate hike cycle which is seen to be in Q4/2015. The domestic cues are mixed, and data dependent for clarity on RBI monetary policy stance ahead. At this stage, expectation is for rate pause till end of Q3/2015. By then, if RBI review the CPI outlook from 6% to 5.5%, there is possibility of 25 bps rate cut in October review. If CPI outlook stays high at 5.5-6.0%, then it would be an extended rate pause with risk of hike dependent on FED stance. All taken, the way ahead is not clear, hence prudent to stay light and fleet-footed with neutral bias on range break-out. The possibility of 25 bps rate cut in October or extended pause through FY16 will retain stability in NIFTY at 7800/7950-8450/8600 till October monetary policy review, before shifting focus to either 7500-7600 or 9000-9150.

Have a great week ahead; Good luck!

Moses Harding