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Why has Optimism Returned to Indian Stock Markets?

05 August 20225 mins read by Angel One
Why has Optimism Returned to Indian Stock Markets?
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On the 25th of May; the day of May F&O expiry there was a clear sense of drama in the markets. If a trader had left his office at 1.30 pm in the afternoon, after being exasperated by the dull markets, he would have been in for a shock by the time he would have reached home at 2.30 pm. A market that was battling bears for the first 5 hours suddenly veered towards a new high on the back of a mix of aggressive buying at lower levels and panic short covering by traders. Scratch the surface and actually you find a method in the madness. In fact, there were four key developments that turned the market tide during the week gone by…

1. FOMC’s stance on the Fed Funds rate…

That was certainly the big story of the week with the Fed admitting that they would be compelled to consider global factors before embarking on the next rate hike. The prospects of additional 3 rate hikes in this calendar year are now almost ruled out. The Fed has made it clear that, at best, there could be two rate hikes this year and the Fed Fund Futures have assigned just a 50% probability even to the possibility of 2 rate hikes. This takes away the immediate risk for the Indian markets pertaining to the rate differential between the US benchmark yields and the Indian benchmark yields. It also soothes the nerves about the prospects of foreign portfolio investors (FPIs) turning risk-off and preferring the safety of developed markers over the risk of emerging markets. It is now clear that neither of these risks look likely in the current calendar year. That gives the RBI a lot more leeway to manoeuvre its monetary policy.

2. Markets are pleased that the taper will be calibrated…

This was another key take-away from the FOMC minutes. The language of the minutes is very clear that the tapering of the $4.5 trillion bond portfolio will be gradual and calibrated. Indian markets were more worried about the liquidity crunch that could be created by the Fed taper. Let us understand this taper! When the financial crisis first struck in 2008, the Fed intervened to infuse liquidity in the system by buying up bonds from the institutions. During the last 8 years, the bond portfolio of the US Fed has gone up to $4.5 trillion and the pressure was mounting on the Fed to unwind this bond portfolio. The rally in equities since 2009 was supported by excess liquidity in the system. If that liquidity is sucked out of the system, the entire equity story could reverse. With the Fed promising a calibrated taper of its bond portfolio, the risk of liquidity crunch no longer exists.

3. Indications of weak oil prices were already there…

Even before the OPEC finally announced the decision the expectations had already been built. The OPEC extended its oil quotas by another 9 months, which was never in doubt. What disappointed the markets was that there was no proposal to increase the quota from the current level of 1.8 million barrels per day (bpd). Currently, the OPEC contributes 1.2 million bpd to supply cut while friendly non-OPEC nations contribute 0.6 million bpd. These friendly non-OPEC nations principally include Russia, Mexico and Kazakhstan. By not increasing the quantum of cuts, the oil prices will remain under pressure due to the onslaught of US shale and the oil market will remain oversupplied. Additionally, Trump’s decision to dispose 50% of American oil reserves is also a price dampener. For India that was good news. It will mean that landed cost of crude oil will remain low and India does not need to worry about imported inflation. That expectation was also a big prop for markets.

4. Technical factors also contributed to the rally…

The market technicals also played a very important role in the sharp bounce in the Nifty and the Sensex. Firstly, banks continued to report strong numbers. While the problems of NPAs still remain, private banks have seen expansion in NIMs and PSU banks are seeing a turn around. With a weightage of 30% in the Nifty, the bank index provided technical support for the markets. Secondly, it is commonly believed in markets that the index bounces, not when buying emerges, but when selling vanishes. At lower levels, there was clear unwillingness among traders to sell their positions and that forced many short traders to aggressively cover their shorts. Coupled with institutional and investment buying at lower levels, the markets had nowhere to go but up. It was this unwillingness to sell that created a market bottom and made the market bounce back so sharply.

In a nutshell, the bounce in markets appears to be quite decisive. Of course, the sustainability of any equity market rally will predicate on a number of factors. But we appear to have seen a confluence of technical and fundamental factors to create an intermediate market bottom. The real rally may be about to just begin!

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