India Markets Weekahead: Savage correction but time to buy

September 24, 2011

(The views expressed in this column are the author’s own and do not represent those of Reuters)

Markets succumbed to selling pressure and the Nifty corrected to nearly 4,800 levels taking YTD losses to 20 pct. Two key events dominated the markets this week, namely the falling rupee and ‘operation twist’ by the U.S. Fed.

Sentiments deteriorated further on indications that nearly a quarter of the top 100 companies have paid lower advance tax in Q2 FY11, highlighting slowdown in growth and margin pressure on account of high input costs and interest burden.

The much awaited outcome of the U.S. Fed meeting was dreadful as global equities plunged. The Fed will buy $400 bln in longer-dated securities in the period until mid-2012 through the selling of shorter-term securities. It remained downbeat on the economic situation and refrained from introducing further quantitative easing at this stage while keeping all policy options open.

This in turn triggered a sharp deterioration in risk appetite which pushed the dollar sharply higher. The rupee was subjected to further selling pressure during the week and dipped to 28-month lows beyond 49.80. There were expectations that the Reserve Bank of India (RBI) will intervene, but it later stated that it will only control volatility and not the direction of the rupee. With severe cuts seen on all asset markets, there are still enough reasons to expect that the rupee will continue to remain weak in the short term.

On the face of it, the depreciating rupee is a sign of worry for Indian policymakers and it affects the economy in several ways. It increases the oil import cost, resulting in a higher current account deficit. A depreciating rupee would also further intensify the inflation scenario of the country which is still ruling above 9 pct. But practically, a different game may play out. With commodity prices, including oil, crashing and expected to remain weak, this could more than balance out the depreciated rupee — which could control rising deficit and reduce input costs for the economy.

Secondly, the strength in dollar seems to be a short-term phenomenon due to investors’ knee-jerk “flight to safety” reaction. Hence, we expect the rupee to bounce back to sub-45 levels in the next few months, whereas commodity prices could remain soft due to the slowing down of demand in the world economy.  The most sought-after asset class of precious metals also saw a battering on Friday. Hence, after an initial bout of risk aversion, people would look for relatively better returns and would be forced to look at emerging equity markets which have underperformed for a while.

Though the near-term situation seems bleak and a prolonged crisis in the developed world has once again exposed the vulnerability of emerging nations to capital flight, the arguments in favour of investing in emerging markets, especially India, remains by and large long-standing on account of inherent advantages.

Having said that, it does not mean that India is immune to various global events, but the fact is that we are better off due to our more inward driven economy. Thus, investors willing to commit their capital for a longer term can look upon the current crisis as an opportunity to buy good quality stocks at bargain prices.

Market valuations are attractive at 13x its FY12E earnings. However, these figures stand true for large caps while some sections of the market (FMCG, consumer durables and pharmaceuticals) are still trading at expensive valuations. Capital goods and infrastructure have come to a level where the valuations have become attractive enough to take the risk of contrarian investments, as most of the negatives such as the structural problems of execution delays, drying capex and high interest rate costs seem to have been priced in.

The coming week would be a dry one in terms of global and domestic market cues. Nonetheless, we have derivative contract expiry on Thursday which is expected to keep volatility high. As long as the Nifty holds above 4,750-4,800 band, one can infer that we are still in the consolidation band of 4,750-4,800 to 5,200-5,250. A break below the lower end of this band will ring alarm bells even for investors with high conviction and we may see a contagion which can lead Nifty to even 4,200- 4,300 levels. But those who believe in waiting for lower levels may end up waiting perennially.

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