Markets Moving Towards A New High

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The script of the markets has played out more or less the way I thought that it should. The last article I wrote was prior to BREXIT and the key recommendation at that stage was to ride out the event to play the strong rally that would play out in the second half of 2016. BREXIT newsflow is through now, the actual even might happen sometime in 2018 and we will talk about it at that stage. My big thesis of a Huge Rally in PSU Banks in the second half along with an overall rally of 10-15% seems to be paying out and should continue going forward with most PSU Banks up 15-50% already in July. I believe that we will see new markets highs over the next few months and the key drivers will be

1. US MARKETS BREAKOUT FROM CONSOLIDATION PHASE- US markets have broken out of a two year consolidation phase last week. Normally these breakouts are significant once they happen after a long period of time and have significant upside potentials. A mirror image of this is seen in the Indian Markets Mid Cap indices chart where the NIFTY MIDCAP index is similarly breaking out after a two year consolidation. These breakouts are a reflection of market psychology as during the phase of consolidation the cash positions have got built up as a greater number of market participants were of the view that the breakout will be on the downside. Hedge Funds were high on cash and low on Net Longs and in general there was scepticism due to the general belief that things are bad. US Markets have the biggest market capitalization worldwide and this move will bring in much more buying across global equity markets.
2. CASH POSITIONS ARE VERY HIGH- Cash positions with funds globally are very high. As per estimates they are today the highest since September 2011. This was due to fear of slowing growth, Fed Rate Hike, Brexit etc etc. However as markets have not corrected and have now entered a seasonally strong period of July to September I am of the view that a lot of this cash will now be deployed in the markets. Hedge Funds will also be forced to cover their short positions of hedges as the strategy fails. Emerging Markets in specific have had very muted flows to outflows for several months now. As the price performance improves, especially of the largest component of the EM Universe i.e. China we will see increased flows into Emerging Markets too which will drive EM outperformance. With FED Hike also getting deferred we should see greater comfort in the minds of investors about EM’s.
3. MACRO OUTLOOK IN INDIA IS GETTING STRONGER- The macro outlook for India continues to improve. Although inflation has picked up in the near term the future expectations of inflation have come down and this is reflected in the kind of rally we are seeing in the Bond Markets. System liquidity has improved significantly and as a result the market rates expecially in the CP market have come down. The monsoons have been very strong and will drive much lower food inflation going forward and as such we are likely to have seen the peak for CPI Inflation in the current month. The Pay Commission recommendations have been implemented now and will drive consumer demand going forward into the festival season. Government revenues continue to grow strongly, thus improving their ability to stimulate the economy. After an initial burst commodity prices have also started to correct and consolidate thus reducing future inflationary pressures. Economic activity has started to improve and should become much stronger going into the second half of the year. Added to this is the potential of the GST Legislation finally seeing the light of the day over the next couple of months. A combination of all these factors today creates a scenario where the probability of acceleration in economic growth is strong over the next 2-3 years.
4. DOMESTIC FUNDS FLOW INTO EQUITIES IS STRONG- Domestic funds flow into equities both into Mutual Funds as well as Insurance Companies continues to be strong. A lot of the traditional investment baskets like Real Estate, Gold etc have gone out of flavour due to non performance as well as the strike down on cash dealings. As growth picks up I expect the flows into Equity will only accelerate going forward and should exceed $ 1 billion per month soon. Greater domestic flows create stability as well as have the impact of driving the broader markets higher. This is something which we should see over the coming months and years.

CONCLUSION

Overall macro environment in India today is the strongest in the last many years. Amidst uncertainty surrounding global growth things in India have now stabilized. Infrastructure investments and improvement in consumption is likely to lead the growth cycle which will be followed by the revival in private sector capital expenditure which continues to be subdued given enough of slack capacity across industries. The current quarter earnings growth expectations are subdued and will be much better as we move through the years. I expect new highs for the markets within this calendar year followed by good markets over the next couple of years as growth gets entrenched.

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