The bulls are back in action after a prolonged spell of hibernation. The last couple of weeks have seen a serious return of enthusiasm in the markets. The indices have been scaling new highs everyday, and the enthusiasm has also rubbed off on the rupee, which is now trading at its highest levels in eight months. The feel-good factor seems to have returned almost overnight.
While it is nice to see some optimism finally, it is important that we understand what’s driving this and if it’s sustainable. Foreign institutional investors (FII) are the motive force behind the current rally. They have pumped in over $2 billion this month alone, and if their words and deeds are anything to go by, they appear set to take the party to the next level. Goldman Sachs, for example, upgraded India to ‘overweight’ from ‘market weight’ a few days ago.
Whatever happened to all that talk of how the Federal Reserve’s tapering will drain cash out of emerging markets?
The answer that analysts proffer is that the FIIs are enthused by the prospect of a stable and favourable government (read, NDA) coming to power at the Centre post-elections. It does appear that the FIIs have some mysterious device to predict the future; it is unimaginable how in the prevailing confusing milieu anybody can even hazard a guess on the next government.
No fundamental cause for optimismBe that as it may, it is important that retail investors are not carried away by the sudden turnaround in sentiment for there is no fundamental cause for optimism right now.
There seem to be more reasons to be cautious than optimistic from an economic and governance standpoint. First, there is no dramatic change in the economic fundamentals. Industrial output is refusing to take off, and companies are still coping with falling demand.
Corporate earnings growth for the fourth quarter, and indeed 2013-14, are likely to be in the low single digits, thus making some of the current valuations rich. With the rupee displaying some vitality, IT and pharma companies are likely to be in a spot of trouble unless if they have been smart in hedging their exposures. The rupee has appreciated some 13 per cent from its all-time low of 68.85 versus the dollar; since January it has risen about 4 per cent and almost all of that has been in the last few days.
Yes, inflation is on a downward trajectory, but there is no assurance that it will continue to remain so. Much of the softening is attributable to a fall in prices of food commodities, especially vegetables and fruits, which is a regular phenomenon in winter. With summer now upon us, food commodity prices are bound to start rising again.
Genuine worriesThere are genuine worries over the fiscal deficit, which is likely to be higher than the 4.1 per cent that the exiting Finance Minister P. Chidambaram has targeted.
This will pose tremendous problems for the next government, especially because it will have to deal with subsidy payments that have been pushed to the next fiscal year to dress up the 2013-14 numbers.
There are also fears of the El Nino this year, a phenomenon caused by warming of the Pacific Ocean waters that has resulted in poor monsoons in India in the past. Agriculture, backed by a bountiful monsoon, was the saviour in 2013-14 and with industry yet to recover, a poor monsoon this year will cause a significant dent to the economy.
Overriding all these, of course, is the political risk. The first phase of polls is just about a week away but there is still little clarity over whether we will have a stable formation at the Centre. Opinion polls predict a clear lead for the BJP and the NDA, but they also show that the formation would still be short of an absolute majority. Such polls have been known to go horribly wrong in the past but yet it should be clear even to a lay observer that no single horse has pulled significantly ahead of the pack yet.
The optimism of the markets and the FIIs thus seem based more on hope than reality and to drive up valuations based on this is risky. There are also genuine doubts over the provenance of the so-called FII money that is now flowing in.
Analysts and observers are speculating that this is nothing but money stashed abroad returning to fund the elections. To be sure, there is little to prove such a hypothesis and if anybody will have an idea, it will be the RBI and SEBI.
The bottomline for retail investors is clear: invest, if you must, with an ultra-short-term perspective, set realistic return targets and exit when you hit them.
raghuvir.s@thehindu.co.in
