Markets continued their one way move upwards with barely a pause showing scant regard to the rain caused disruptions in Mumbai. Even the trading holiday on Thursday after banking operations came to a halt in Mumbai, could not upset the indices much.
Banks led the way throughout the week even as more cautious market watchers termed the surge in stock prices as crazy. Robust FII inflows and massive short covering ahead of the monthly derivatives settlement saw the indices seeking new life time highs on most of the days.
The fire in one of the production facilities of ONGC and losses reported by 2 of oil marketing companies did not dampen the market momentum. Lower than expected first quarter results from frontline steel companies like Tata Steel and SAIL also could not rein in the market surge, though these stocks corrected during the week.
The Sensex crossed the 7600 mark comfortably during the week and touched 7700 on Friday before selective selling forced the index to close below that mark. Gains on the Nifty were lower as weakness in ONGC and the sideways movement in some of the technology majors held its gains.
Mid-caps underperformed the frontline stocks throughout the week as many momentum stocks saw deep correction. Poor first quarter numbers from some of these companies added to the pain in smaller caps. The CNX Mid-Cap 100 index closed the week on a weak note on Friday.
Domestic economic and regulatory action
- The quarterly review of the RBI's annual credit policy left all benchmark rates unchanged. The central bank may have been encouraged by the stable price levels despite the modest hike in fuel prices effected in June. Besides, the policy makers definitely do not want to derail the recovery in manufacturing growth by reining in credit growth.
While describing the credit growth as very strong and beyond expectation, the RBI governor stated that the growth is well diversified and healthy. In two of the sectors were the early signs of froth is visible, commercial real estate and capital markets, the central bank has increased the risk weightage on bank exposures.
RBI expects the economy to grow within the range 6 to 7.2 per cent during the current year as the monsoons have been good and industrial production has surged ahead. Inflation has been pegged at between 5 and 5.5 per cent.
- The monsoons have in fact been too strong this week, sinking most of Mumbai under water. It was not a pretty sight to see the commercial capital of the country and an aspiring regional financial centre completely shut down for more than 2 days. Despite all the talk of converting Mumbai into another Shanghai, the ground realities remain depressing.
We first heard of these grand plans in the nearly nineties and the city does not even have a good drainage system even after a decade and half. The city is left to pride itself on the efficiency of its local rail network and forget the fact that the network is grossly inadequate and so uncomfortable to commuters. Delhi, where travel by public transport is considered as demeaning unlike Mumbai where everybody travels by local train, got a swanky new metro system. A similar one is only being considered for Mumbai!
The left parties and sections within the congress party expect Mumbaikars to feel proud about the only slum in the world which has an international airport within it. Their efforts to block the eviction of encroachers on airport land cannot be justified in any other way.
- Coming back to monsoons, despite the rain caused calamities in Gujarat and Mumbai, the rest of the country has much to thank the rain gods for this year. Andhra Pradesh, which did not receive sufficient rainfall even last year when most of the country received enough, is all set to bounce back after years of drought. The 2 week delay in arrival of monsoons and the subsequent shortfall in June have been more than compensated.
When the monsoons were delayed in June, one of the most respected economic think tanks in the country jumped the gun and predicted a bad year for agriculture. The institution went a step ahead and lowered their economic growth projections for the current year, stating that manufacturing would find it difficult to come up with a repeat performance after last year's excellent showing. Thankfully for the country and our economy, both their prognosis have been proved incorrect within 2 months.
- Inflation for the week ended 16 July inched up marginally to 4.18 per cent from 4.14 per cent reported for the previous week. The rise was mostly on account of increase in prices of food articles, manufactured goods and energy.
- Once again the stock market regulator seems to be blind to the huge run up in the stock prices of a company belonging to a prominent industrial group before a major announcement. The stock price of Tata group company VSNL has been going up for some weeks now seemingly without any reason. It is now obvious that at least some of the large operators were aware of the impending acquisition announcement while ordinary investors had no clue about it.
The VSNL case comes after similar run ups in counters like Reliance Energy, Reliance Capital etc before major announcements. The periodic surges in Reliance group stocks before the final settlement between the brothers are still fresh in memory. In these cases also, SEBI has not initiated any enquiry. They have not even checked the trading patterns with the stock exchanges. The regulator is after hapless FII's for causing the market crash on Black Monday as it is more convenient.
If the regulator cannot control these unhealthy and unfair practices at least in frontline stocks, such practices could eventually lead to a disaster. Even these days, nothing prevents a group of operators from spreading a rumour about a possible acquisition and rig up stock prices. And this is a country where people get killed because of rumours, like this week in Mumbai about a tsunami and a dam breach! While our systems have improved much, some of our market practices have hardly changed from the bad days before nineties.
- The first two quarterly results from PSU oil marketing companies were on expected lines, with both Indian Oil and BPCL reporting losses. It was certain that these companies would report losses as the fuel price increase in June came in too late and too less. With crude prices refusing to cool off from the $60 per barrel levels, the oil marketing companies would continue to bleed in the current quarter as well unless the government decides to raise prices further.
More than a couple of quarters in the red, the impact of price under-recoveries on the long term plans of these companies are considerable. For an energy hungry growing economy like India, it is very important that the frontline energy sector companies have the capability to make large scale investments in building capacities.
As India does not have enough hydrocarbon reserves, the energy sector needs to acquire more and more oil and gas assets abroad. The competition to Indian companies in this quest comes from Chinese companies which are all financially sound. The Chinese government is also willing to financially back them like in the recent bid by CNOOC for US oil company Unocal.
However in India, the government is adopting the policy of milking the oil companies to score political points by providing subsidised fuel. To make matters worse, the government often force them to make large dividend payouts to improve government finances. Companies which need to make large capital investments are forced to part with internally generated funds by way of additional dividends! At the same time, the government expects them to take up large scale investments too.
Indian Oil has already stated that its poor financial performance would affect its ability to take up large investments, both in the domestic market and abroad. The company has bid for a 51 per cent stake in a large Turkish refining company and also has plans to set up a massive export oriented refinery with a capacity of 60 million tonnes per annum.
Even ONGC, which has the most financial resources among all oil sector PSU's, would find it difficult to take up large projects if the current situation continues. Apart from the higher subsidy burden forced on it this year, ONGC will also have to make investments to bring back the facilities destroyed by this week's fire.
The oil minister was seen bragging on television that ONGC has the ability to raise up to $25 billion to finance its future plans. This is not an empty claim; the company indeed has the capability to do so. The worry is about its future repayment capacity, if crude oil prices were to remain at these levels and the company is forced to pay for the subsidies. Besides, is $25 billion enough to finance our entire hydrocarbon related acquisitions and capacity build up?
- The huge rally in bank stocks over the last 2 weeks has taken most analysts by surprise. What struck the most was the speed with which the frontline banking stocks surged. Three of the largest banks, SBI, ICICI Bank and HDFC Bank led the charge from the front, all of them posting new life time highs.
The decision of the RBI to leave short term interest rates unchanged added fuel to the rally in banking stocks. Most analysts were betting on a 25 basis points rise in the reverse repo rate which would have led to a decline in bond prices. A decline in bond prices would have in turn led to some losses on bond portfolios of those banks which have not shifted their holdings to the held-to-maturity category.
Traders are betting on improved interest spreads for banks as many of them had raised the interest rates on some categories of lending recently. The rate hikes had come mostly on retail loans which is the fastest growing category even for SBI. Since short term interest rates were left unchanged, the belief is that there would be no need to raise deposit rates and hence interest spread would go up.
Though this may be true in the short term, the situation may change dramatically. As mentioned in this column earlier, growth in bank advances is running way ahead of growth in deposits even in absolute terms. Banks are currently meeting the credit requirements by running down their bond holdings which obviously cannot go on forever. Sooner than later, banks would be forced to make deposit rates more attractive.
Another negative in the medium term is the introduction of Basel 2 norms which would force banks to improve their capital adequacy. Most of the frontline banks would have to raise fresh capital to meet the requirements under Basel. Equity dilution is generally not good news for stock prices. But strange things happen in a bull market and the markets may bid up bank stocks ahead of such issues as was seen in the case of the PNB public issue a few months back.
US markets, economy and oil
The US indices closed the week on a low note but gains for the month on all 3 widely followed indices like the Dow, NASDAQ and S&P 500 were impressive between 3 to 6 per cent. For the week, the major indices were little changed.
Though economic numbers were strong, the stock markets were affected by falling bond prices. The decline in bond prices has pushed up bond yields to a 3 month high and traders have started worrying about a diversion of investments from stocks to bonds. Robust economic growth may also lead to further short term interest rate hikes. The US markets were also affected by the rise in crude prices.
The US economy expanded 3.4 per cent during the April-June quarter as against 3.8 per cent reported for the Jan-March quarter. This is the ninth straight quarterly growth of over 3 per cent for the US economy. If not for a decline in inventory build up, the second quarter growth would have been much higher.
The International Monetary Fund expects the US economy to grow at the rate of 3.5 per cent for this year and the next. In its annual review of the US economy, the IMF said higher inflationary pressures may lead to more aggressive hikes in short term interest rates. Stable growth in the US has helped global economic growth over the last few years and the IMF expects the situation to remain unchanged in the medium term.
The IMF continues to be worried about the huge fiscal imbalances in the US and has urged the government to correct them through tax adjustments. The institution also believes that the US Dollar continues to be overvalued despite the 12 per cent depreciation over the past 3 years, adjusted for inflation.
Crude prices bounced back during the week and closed well above the $60 to a barrel mark for September futures on NYMEX. The latest upsurge was caused by a blast at a Texas refinery owned by British Petroleum. Another US refinery of BP had been severely damaged earlier this year.
Crude gained more than 3 per cent during the week and closed at $60.57 to a barrel, within striking distance of all time high of $62.1. The commodity is expected to rise next week as no signs of an economic slowdown are visible in any of the large consuming markets like US, China and India.
*Disclaimer: The author doesn't have any position in the stocks specifically mentioned above at the time of writing this article. This analysis/report is only for the purpose of information and is not an investment advice. Readers are advised to consult a certified financial advisor before taking any investment decisions. While efforts have been made to ensure the accuracy of the information provided in the content the author or publisher shall not be held responsible for any loss caused to any person whatsoever.