Will Indian stocks end 2012 on a happier note?

November 26, 2012

(Rajiv Deep Bajaj is the Vice Chairman and Managing Director of Bajaj Capital Ltd. The views expressed in this column are his own and do not represent those of Reuters)

The rally in the Indian stock markets, fuelled by the so-called reform announcements, seems to have fizzled out. Frontline indexes have retraced more than 60 percent of the gains made since Sep. 13, 2012, the day the reform measures were made public.

Stock market sentiment turned bullish after the reforms were announced, which typically followed Europe’s unlimited bond-buying plan revealed a week earlier and coincided with the launch of QE3 in the United States.

However, subsequent developments such as the Reserve Bank of India’s (RBI) refusal to cut the repo rate citing persistently high inflation at its October policy review, slowing growth and worsening trade and fiscal deficits, have dented some of that exuberance.

Fiscal concerns seem to have staged a comeback. The 2G spectrum auctions fetched not even a fourth of the targeted amount (400 billion rupees) and the disinvestment process is yet to take off. The fiscal deficit for 2012-13 runs the risk of exceeding even the revised target of 5.3 percent of GDP. Also, despite a weaker rupee and slowing domestic growth, the trade deficit continued to expand, clocking a high of $21 billion in October. As a result, the rupee has slipped back to 55 plus levels.

Concerns over the “fiscal cliff” in the United States and renewed concerns on Greece have given rise to risk-off trade overseas, thereby affecting liquidity flows in India.

If we weed out the reform announcements for a moment, then the movement of the Indian stock markets from September onwards can be attributed to two factors — the initial upside due to risk-on trade following QEs in Europe and the United States, and later the downside due to risk-off trade after concerns on the U.S. “fiscal cliff” and Greece.

The approaching “fiscal cliff” is a game of brinkmanship in which both parties will ultimately yield, but not before extracting their pound of flesh. This may lead to some anxiety in global investment markets, but the probability of this escalating into a full-blown crisis is low.

Fundamentally, corporate earnings growth seems to have bottomed out in the July-Sept 2012 quarter. Going ahead, earnings downgrades should give way to earnings upgrades. But recovery is likely to be slow. Present valuations, though not screamingly cheap, are not expensive either. At close to 14 times one-year forward EPS, the BSE Sensex is trading in the fair value range.

The most important factor, however, is global commodity prices. They seem to have ended the 15-year bull cycle and are headed for a deep correction. Lower commodity prices can be a boon for India, which imports almost 70-80 percent of its commodity requirements.

Add to that the subtle rate cut hints from the RBI in the Jan-March 2013 quarter and we may be headed for a much-needed reprieve. Technically, the markets seem to have completed a healthy correction to the previous rally and are at crucial support levels. Pessimism and disbelief seem to be rampant among investors as they have used this rally to book profits. The markets have a habit of doing exactly the opposite of what the masses want them to do.

The ongoing winter session in parliament is crucial as a number of important bills will come up for approval. Bills related to FDI in insurance and pension, Companies Bill (Amendment) and Land Acquisition Bill are some of the important ones that need to be passed for the recent upswing in sentiment to continue.

The opposition has plans to push for a vote on FDI in retail, whereas the government is trying its best not to let it happen. A lot will depend on how many reform bills are passed in this session. Will it be another wasted opportunity? Or will it finally herald the beginning of a new era? The near-term future of stock markets depends on that. We are keeping our fingers crossed.

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