How much worse can the markets get?

The risk of the unknown has led to risk averseness in the global financial system, resulting in price correction in all risky assets including equities, commodities and currency

Rajesh Kumar, Mint 15/5/12

The stock market is getting beaten down; the BSE Sensex lost at least 2,200 points from the highs of February. Global factors, primarily emanating from the euro zone, high fiscal and current account deficit and no move on the policy front back home are some of the factors the markets are reeling under.

The postponement of general anti-avoidance rules (GAAR) by a year, which was proposed in the Union budget, failed to lift the market mood; neither did the clarification calm the frayed nerves of foreign institutional investors (FIIs). Though some buying activity was seen on the day the government postponed the implementation of GAAR, it very quickly got overshadowed by pessimism and uncertainty in the global environment.

The future course of the market will, therefore, depend on both domestic and global factors.

The ongoing sovereign debt crisis is believed to have reached a critical juncture with voters in two countries—Greece and France—rejecting political formations supporting austerity as a way out of the current crisis. While it is still to be seen how policy shapes up in France, the possibility of Greece leaving the single currency union has gone up significantly in the last couple of weeks.

Risk of the unknown: The risk of the unknown has led to risk averseness in the global financial system, resulting in price correction in all risky assets including equities, commodities and currency.

Says Andrew Holland, CEO, investment advisory, Ambit Capital Pvt. Ltd: “The biggest risk is from Europe and people don’t know what is really going to happen.”

The possibilities: There are two scenarios that one can anticipate if Greece decides to leave the single currency. First, if Greece exits euro suddenly, there will be mass selling of financial assets in the global market and banks with exposure to the Greek government debt may find themselves in trouble. Very quickly government bonds in other weaker links in the region, including Portugal, Spain and Italy, will come under fire, leading to deeper problems in the banking and financial sector in the region. The chain reaction could possibly lead to an outcome similar to what was witnessed after the collapse of Lehman Brothers in 2008. The BSE Sensex sunk to 8,100 in March 2009.

Second, if Greece leaves the euro in an orderly way, damage in the financial market will be restricted. However, political decisions are not always based on sound economic principles, hence the uncertainty.

If Greece continues to remain in the euro, things are unlikely to look up in any case.

The domestic environment is not supportive for the market either. The growth in the Index of Industrial Production (IIP) for March (figures released on 11 May) showed a negative reading of 3.5%, pulling down the full-year growth for FY12 to 2.8%. This could mean that the gross domestic product (GDP) for FY12 may now come below the anticipated 6.9%. Then, with slowing economic growth, it will always be difficult for markets to scale up.

Says Jagannadham Thunuguntla, strategist and head of research, SMC Global Securities Ltd, a financial services firm: “Growth is like red carpet, once the carpet is removed, lot of dust starts getting visible.” He explains that India always had governance issues and current account deficit, but everybody was attracted by growth. But if growth slows, things will get difficult. And there is sufficient indication of falling investment and growth.

The combination of both external and internal risks has significantly increased the downside risk in the market. Thunuguntla puts the near-term target on Sensex at 15,000. Agrees Harendra Kumar, managing director and head (institutional equities and global research), Elara Capital Plc, putting a similar number on Sensex. Kumar believes that earnings will bottom out around the third quarter of the current fiscal.

Apart from the levels of the Sensex and the Nifty, markets are also worried about the fate of the rupee. The Indian rupee hit a new low of 53.96 against the US dollar on 14 May. A weakening rupee, apart from creating uncertainty on the macroeconomic front, works as a disincentive for FIIs investing in India as they get fewer dollars against the same level of rupee realizations. Says D.K. Joshi, chief economist, Crisil Ltd, a global analytics and ratings firm: “The rupee will remain volatile and in the near term can go down further. But fundamentally, our medium-term call is that rupee will appreciate to 49 by March 2013.” He further explains that it’s not risk but uncertainty that is playing in the currency market.

Waiting for the right levels should not be an option for equity investors since it is difficult to catch the bottom.

“We think this new bout of risk aversion may continue until there is some clarity on the European issues, implying that the risk of further sell-offs remains high. However, continued weak investor sentiment may turn the commodity price factor in India’s favour along with prospects of further global liquidity easing,” according to a recent note from Macquarie Capital Securities India. Pvt. Ltd, a financial services firm. The note further mentions that it may be a good time to add fundamentally good stocks that have corrected.

Holland adds the market has ignored positives, including correction in oil prices, which will help inflation and rupee, and the fact that there has been no major FII outflow. Even in terms of valuation on trailing basis, Sensex is currently trading at 16.6 times compared with a five-year average of 19.64.

Direct equity investors should pick fundamentally strong stocks with reasonable earnings visibility. Investors taking the mutual fund route should continue their systematic investment plans.


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