Sunny days again for the markets?

Sharp drop in oil prices, less concerns about a hard-landing for the US economy and easing fears of interest rate hikes have helped improve the outlook for global equity markets. By Rex Mathew.

After showing some nervousness following the sharp fall on Monday, the markets have pulled back and reclaimed all the losses. The Sensex today touched the 12000-mark for the first time since May and the Nifty has moved closer to 3500.

The pull back rally, which started in July, after the May-June carnage, is showing strength much beyond expectations. Traders are much more confident now, which is clear from the sharp recovery on Wednesday, and mid-cap stocks are flying around. Some of the large-cap index stocks have gone past their previous highs touched in May.

Global markets have also rallied over the last couple of months and some of them have moved closer to the year highs scaled in May. In the US, the Dow Jones index is back above 11500 while the NASDAQ has erased all its losses for the year. The Japanese Nikkei is inching closer to 16000 and other Asian markets are also doing well.

Oil is not boiling anymore
The sharp drop in crude oil prices has been the most beneficial development for global equity markets in recent weeks. After touching an all-time high of over $78 per barrel last month, oil prices on the NYMEX declined 18 per cent to below $64 on Tuesday.

Prices of other commodities have also come off and analysts have started talking about a major correction in commodity prices after the sustained rally over the last few years. Though a deep correction in commodity prices would affect stock markets as commodity stocks would be severely hit, modest declines would help equities as inflation would be under check.

Not yet a hard landing in the US
Most market analysts and economists were concerned that the US economy was heading for a sharp slowdown in the coming quarters. Slower US growth would have impacted global growth and sentiments across other global equity markets.

Second quarter US GDP growth was substantially lower and the decline in housing market would have pulled down economic growth further in the near future. Consumer spending was showing early signs of a slowdown on higher fuel costs and weak housing market.

As oil prices have declined, one of the factors affecting US consumer spending has eased. Retail gasoline or petrol prices in the US have come down to below $2.6 per gallon from over $3 last month. That should help in keeping consumer spending at least at current levels.

Corporate spending has so far not shown any decline and would remain firm as long as there is no sharp drop in consumer spending which would have pulled down corporate profitability.

Property prices remain subdued across the US, but that is mostly because of a housing inventory build-up in major centres. If consumer confidence remains strong and there are no further hikes in interest rates, property prices may not see further declines and may even recover by early next year.

Easing global rate hike concerns
As oil prices have eased, it is almost certain that the US Fed would decide to hold interest rates at current levels in the short term. The Fed's interest setting committee is meeting later this month.

Though inflation in the US still remains a worry, the Fed may decide to wait a bit longer and see the impact of lower fuel prices on overall price levels. If oil prices remain at these levels and inflation subsides later in the year as expected, the Fed may even contemplate rate cuts by early next year.

The European Central Bank (ECB) and Bank of Japan have also kept interest rates steady recently. The ECB may go in for a rate hike next month, but the pressure to increase rates further would ease if oil prices remain low. Bank of Japan is expected to go in for a rate hike only if inflation starts threatening the ongoing economic recovery.

Strong domestic growth
Going by the performance during the first quarter, domestic GDP growth should remain above 8 per cent this financial year as well. Industrial growth is very strong, recording the best monthly growth rate in more than a decade during July 2006, and agriculture is expected to do close to 3 per cent this year also.

Corporate performance should remain strong this year as all sectors are performing well. Global opportunities for Indian companies have increased considerably and should increase further as long as global economic growth remains strong. Margins have been under pressure recently, but volume growth would compensate for most of that.

The finance minister feels that there is no pressure on domestic interest rates despite strong industrial expansion. But the RBI is likely to go in for a 25- basis points rate hike late in October as growth is very strong and inflation remains around 5 per cent. Modest rate hikes would only have a calming influence and would not upset the growth momentum.

Hence listed companies should continue to report good growth in the coming quarters. That should support the market momentum, which would be threatened only in the event of a major global sell-off like the one in May-June. In such an event, India may see a sharper initial fall than other emerging markets because of relatively more expensive valuations. However, the strong domestic growth story may lead to a good recovery subsequently.