markets are under a firm bull grip and indices are scaling
new lifetime highs almost everyday. What are the factors,
which could upset market momentum?
moving past their earlier lifetime highs in October, domestic
stock indices have not even bothered to pause before surging
ahead this month as well. Helped by strong inflows from
both domestic and overseas investors, the Sensex and the
Nifty have been scaling new lifetime highs almost on a
daily basis for the last couple of weeks.
again seasoned analysts are surprised by the strength
of the up trend. Not many had expected the indices to
rally past their previous highs as early as October. Some
were predicting a steep correction towards the end of
the year, which would take the indices back to their June,
lows. Even the most optimistic analysts had not predicted
so much, so soon.
helped the markets to break down this wall of scepticism
were the strong second quarter earnings reported by listed
companies. Results from frontline companies, which set
the market sentiment, were above expectations and they
were even more bullish in their guidance for coming quarters.
The performance of some of these companies was so strong
that others whose results were in line with market expectations
were considered laggards and their stocks have remained
factors, which have supported this rally, are domestic
growth momentum, firm global markets and subdued oil prices.
Domestic economic momentum is probably at its strongest
in history and may push growth rate for current financial
year to closer to, if not, 9 per cent. Oil prices have
remained subdued for more than a month now, after declining
over 25 per cent from record highs. Helped by lower oil
prices and steady interest rates, other global markets
have also sustained the up trend in recent months and
major indices like the Dow are at historic highs.
as everything looks very rosy and sustainable, it maybe
worthwhile to analyse the biggest threats, which may derail
this bull-run. Though these risks may appear manageable
at this point, they can worsen in the coming quarters.
If market momentum ebbs next year, such risks may look
all the more threatening.
Strong corporate earnings growth is the single most important
factor driving this rally. Investors are comfortable with
the relatively higher valuations for Indian companies
as they have much better earnings visibility. Besides,
Indian companies are less dependent on global growth and
commodity price cycles for sustaining their earnings growth.
the frontline Indian companies sustain their current growth
rates next year as well? Even if they can, markets may
be disappointed if they cannot exceed expectations on
a sustained basis. Maybe an Infosys or a Bharti would
be able to consistently exceed expectations, but others
are bound to disappoint when expectations continue to
margins have been under pressure for most sectors for
many quarters now. So far, bottom line growth remains
unaffected because of strong volume growth. Even if companies
can protect their current margins, exceeding market expectations
would become increasingly tougher. The high base effect,
after many years of sustained bottom line growth, itself
would make it difficult to sustain growth rates.
Costs would continue to rise in the coming quarters, squeezing
margins further. Shortage of skilled manpower has led
to spiralling wage costs for most fast growing sectors.
Domestic salary levels for middle and senior management
personnel have started touching global levels; with many
senior executives getting million-dollar pay packages.
have also stepped up their capital spending to overcome
capacity constraints and meet rising demand. Incremental
volume growth may come at lower margins because of higher
capital and other costs. Borrowings to finance capital
expenditure may lead to an increase in interest costs,
even if interest rates do not increase further.
of the leading investment banks expect earnings growth
to decline next year, even if the economy continues to
expand at above 8 per cent. Yes, they have been sceptical
in the past too and were proved wrong many times. But
this time around, the weight of expectations is very high
and even a modest disappointment can look disastrous.
and interest rates
Inflation is another important factor, second only to
corporate earnings growth, which could derail market sentiment
next year. Despite very strong economic growth momentum,
domestic inflation has remained within the 5 to 5.5 per
cent target range over the last year and has prompted
the RBI to hold interest rates steady at its quarterly
review meeting last month.
inflation has been on a sustained upswing for the last
many weeks and went very close to 5.5 per cent by the
middle of October. Worryingly, costlier primary articles
including food - are driving inflation when crude
oil prices have remained subdued. Prices of manufactured
goods have also maintained a steady up trend. Higher income
levels of consumers and stagnant output levels are behind
the rising prices of primary articles while higher input
costs have led to costlier manufactured goods. These factors
won't disappear easily and inflation expectations would
remain high next year as well.
decline in crude oil prices would not have much of an
impact on inflation expectations. Government has made
it clear that it would consider a cut in retail fuel prices
only if crude prices drop to $52 per barrel and that is
still some way off.
inflation remains close to the upper end of RBI's target
range, the central bank would be forced to hike interest
rates by January especially since economic growth
momentum is so strong. Most economists now expect a rate
hike in January and some expect the increase to be as
high as 50 basis points. Apart from the obvious impact
on consumer demand growth, higher interest rates would
be an added pressure on corporate margins when companies
are expected to step up their borrowings.
Though India is relatively insulated from a global economic
slowdown because of less reliance on international trade
to sustain growth rates, we are not completely immune
to it either. Slower growth in some of the larger economies
can impact the earnings growth of some of our frontline
technology companies and emerging mid-caps, which rely
economists now expect US economic growth for 2007 to decline
below 2 per cent from over 3 per cent forecast for the
current year. Growth rate may even be worse if the US
housing market continues to decline, which, though unlikely,
is still possible. US corporate spending, which determines
the volume growth for Indian tech companies, has so far
remained strong despite clear signs of economic slowdown.
But that may change, if US consumer spending declines.
US Fed may bring down interest rates next year, but that
is expected only towards the second half. Even if interest
rates come down, it would take some time to revive consumer
sentiment and in turn the housing market.
major economies like the EU and Japan are expected to
do well next year. But Indian companies derive a much
smaller portion of their revenues from these markets.
Overall global growth rate for next year is expected to
decline modestly from around 5 per cent forecast for the
Domestic markets look to inflows from foreign investors
for setting the direction. Even if the inflows were not
very large, as in the current rally, markets would be
all right as long as modest inflows are sustained. But
they still don't have enough depth to absorb any selling
pressure from overseas investors.
the event of any major global sell-off, it is quite likely
that the domestic markets would also go into a tailspin
and lose substantial ground. But as happened post-June,
the markets would climb back as long as corporate performance
does not disappoint in a big way.
if fund flows remain robust, some analysts are worried
that increased supply of fresh paper would suck out liquidity
from the system and halt the rally. It is expected that
Indian companies would raise around $12 billion from the
primary market over the next year.
primary market issues from strong companies have benefited
the markets even when they absorbed some liquidity. It
was the Maruti disinvestment through an offer for sale
by the government, which kicked off this bull-run. When
the TCS IPO was launched, sceptical analysts even blamed
the Tata group for launching such a large issue when the
markets were struggling to sustain an up trend. But the
stock went on to support the rally in a big way and TCS
became the fifth most valuable company.
is largely a misconception that large primary issues dampen
market rallies by sucking out liquidity. On the contrary,
such high profile issues often attract additional inflows
into the markets. Primary issues also bring
other stocks in the same sector into the limelight and
help sustain market momentum. But hyped-up and over-priced
issues can flop and dampen sentiment considerably.
also see : Other
reports by Rex Mathew