InvestorQ : What is the event in the market that can really trigger an upward breakout in the Nifty? I am asking because markets are stuck around the 12,000 levels of the Nifty?
Anu Biswas made post

What is the event in the market that can really trigger an upward breakout in the Nifty? I am asking because markets are stuck around the 12,000 levels of the Nifty?

Neelam Naik answered.
3 years ago

If the indices like Nifty have to break above 12,000 and Sensex has to break above 42,000 decisively, it will have to be a mix of long range reforms, corporate earnings, soft interest policy and support from global macros. Let us look at these drivers.

A distinct focus on long range reforms

The markets are actually expecting a series of long ranging reforms from the current government. The budget has taken a step in the right direction by focusing on fiscal discipline and infrastructure spending. Also, the focus on rural spending will give a spurt to rural demand. Broadly the markets will be looking at three reform assurances from the government. Firstly, the GST Bill needs to be passed. It is currently stuck in the Rajya Sabha as the ruling NDA is in a minority in the Upper House. Most global investors are looking at the GST Bill as a mandate on the government’s reformist credentials. GST Bill is expected to add nearly 2% to the GDP growth once it is implemented. Also its simple nature will go a long way in encouraging the ease of doing business.

Sweeping reforms in infrastructure

Apart from the outlays on infrastructure, the government will have to move ahead on simplifying the PPP (Public-Private Partnership) mechanism. Markets also want to see how the government gets private investors like pension funds and sovereign funds to propel India’s infrastructure investments. The government needs to spend $1 trillion over the next 5 years and this will be impossible without a proper regulatory and policy framework. Lastly, markets will be also looking at the sustenance of fiscal discipline. Any laxity in fiscal discipline will invite a rating downgrade and India cannot afford that at this point of time.

Corporate earnings must show a pick-up

Indian corporate profits have shown negative growth for 4 out of the last 5 quarters. This is not great news for an economy that is growing at 7.5% per annum and valuations are quite rich by global standards. The big problem that Indian companies face today is falling “Return on Equity” (ROE). In fact, ROE has been consistently falling after peaking out in 2007. Most analysts have been building in aggressive growth estimates to justify higher valuations for Indian stocks. The last year was fairly disappointing and any further downside risk to earnings will lead to a re-think in valuations. The markets are expecting Indian companies to get back to a 15-16% profit growth from this fiscal, and that will be a litmus test.

Accommodative interest rates to support a break out on the upside

The good news is that the RBI has continued to maintain a dovish stance on interest rates despite the US talking a hawkish language. Low interest rates are a must if bank credit has to pick up and industry has to get out of its low investment syndrome. There are a few X-factors here. If the US continues with its hawkish stance of raising rates, then the RBI may be forced to halt rate cuts to protect the Indian economy from debt portfolio outflows. That will not be good news for Indian industry. The second item of uncertainty is the inflation; especially food inflation. With an overdependence on monsoon and poor distribution infrastructure, food inflation continues to be sticky. As long as inflation stays high, the RBI may not be too inclined to cut rates aggressively. In short, a dovish interest rate stance by the RBI will be one of the pre-requisites for a stock market pick-up. Remember, when rates are cut, the cost of capital goes down and that provides a valuation boost by discounting future earnings at a lower rate.

Like it or not, global macros will also be a critical factor

One just cannot ignore the oversized impact of global macros. There are quite a few of them. The biggest risk is China and a slowing China means negative growth in most countries that depend on the Chinese economy. This is true of most economies across Australasia, Africa, Middle East and Latin America. A slowing China will also open up the possibility of further devaluation of the Yuan and we have already seen the disastrous consequences last year. Secondly, the US stance on interest rates will be important and it will have to be juxtaposed with what Europe does. We have seen the ECB adopting a very loose policy. If the US Fed continues with its hawkish stance, then it will result in monetary divergence. We saw in January this year how monetary divergence led to a spike in volatility and global markets losing nearly $10 trillion in wealth.

Oil and commodity prices will also be key determinants

Firstly, there are too many important economies like Russia, Australia, Canada, Brazil, Middle East, Indonesia, Norway and others who are entirely dependent on buoyant oil and commodity prices. Weak oil prices will put pressure on these economies and their currencies. Weak oil and commodity prices are also a reflection of weak demand from China and that has its own negative repercussions.

Stock markets need some clear signals before they can break out above the current levels. It will have to be a mix of global macros and domestic policy initiatives. But above all, it will boil down to quarterly earnings. That is where the stressed sectors like PSU banks, pharma and auto stocks will have to show better traction.