What’s Driving the Market and What You Should Do?

The equity market in India has become very volatile these days. Based on our assessment, this can be mainly attributed to the following 3 reasons:

1. Rising global crude oil prices
2. Rising US interest rates
3. Indian state and central elections over the next 7 months

Let us look at the future outlook of these factors:

1. Crude oil prices are rising due to potential supply-side shocks due to impending US sanctions on Iran. The US has asked consumers of Iranian crude oil (China, India etc.) to stop future purchases from Iran and to look for alternate sources of oil. Though Saudi Arabia and other OPEC countries have said they will increase production to offset the fall in supply from Iran, the crude oil market believes that supply will fall short of demand and thus crude oil prices are heading higher.

India, being a net importer of crude oil, is badly hit when prices rise. Higher crude oil price increases imports, depreciate the Rupee, increases fiscal deficit, raises inflation and impacts the overall economic environment of our country.

Based on the latest reports, it seems as though the US may relent on its sanctions and allow Iran to export some of its crude oil. This is due to mid-term elections in the US scheduled for later this year and President Trump cannot afford to antagonize US voters by allowing gasoline prices to rise significantly. On a slightly longer-term basis, at elevated crude oil prices, there is a strong historical correlation of the return of alternate sources of energy such as shale gas and renewables which tend to cap oil prices beyond a certain level.

Thus, there is a possibility that crude oil could rise by another 10%-15% from current levels, but we may be nearing the top soon.

2. US GDP growth and the US economy are at their strongest level in a long time. In this backdrop, the US Federal Reserve has been constantly hiking US interest rates to contain inflation. At higher interest rates, the flow of capital tends to be towards the US debt markets and away from Emerging Market equities (India, Indonesia, Brazil, Philippines etc.).

However, future estimates for US growth (next 1-2 year outlook) are much lower than current 2018 levels. The positive growth boost in the US due to the tax cuts by President Trump is expected to wane. In addition, higher interest rates will increase borrowing costs for local borrowers thereby further slowing the economy. Thus, we may see the top on US rates soon. However, there could be some pain in the short term but it should not last very long.

3. Long-term investors tend to value political stability above all else, especially in emerging markets like India. With 5 state elections during Nov-Dec 2018 and the general election in May 2019, we may not see much foreign capital inflow for the next 7 months. This will likely keep the markets range bound until then.

On the political front, BJP is expected to lose the state elections in Rajasthan by a wide margin and would be in a tough race in MP and Chattisgarh.

At the national level, PM Modi’s prospects of returning with a similar majority to the one he received in 2014 don’t seem likely. The following 2 election scenarios seem to be realistically emerging at the moment:

a) BJP wins 210-230 seats (down from 282) and NDA cobbles together a majority of 280-290 (down from 336).
b) BJP wins more than 200 seats, and a Third Front coalition with support from the Congress emerges.

In either case, the govt. formed will not be as strong as the current one. This has negative implications for the equity markets. However, it is still early days and we would need to keep fine-tuning this analysis as we get closer to the event.

4. Other potential risks include a US stock market sell-off (which hasn’t happened as yet), further widening of India’s current account deficit thereby putting further strain on the Rupee, a worsening of the situation witnessed recently in the domestic credit markets and potential negative impact of trade wars and sanctions.

However, we must balance the above risk factors by mentioning the many positives for India at the moment. Non-fuel inflation is still quite low and contained. Credit growth has picked up. GDP is back at 8% levels as expected by Orowealth last year. Company earnings are on the upswing and manufacturing has picked up again in the country. Financialization of retail savings is on a strong path. Discretionary consumption is on the rise. Tax compliance and collections are also picking up.

Thus, the long-term India story is still intact.

Instead of taking a short-term view which may dilute the essence of an investment plan, it is advisable to take into account the broader picture. Based on our assessment, every investor should be appropriately positioned to a) avoid the pitfalls of a volatile market and b) keep cherry picking when the right opportunity rises; without sacrificing on the long-term positioning of the portfolio towards one’s goals.

We believe the market to be range-bound (Nifty between 9500-11500) over the next 6-7 months. On a tactical basis, you can use every market rise as an opportunity to switch out from equity and every market fall to add to your equity positions.