A Little More To Endure

The quirky movement that the Indian equity indices have witnessed in the past few trading sessions has left the investor fraternity rather baffled. New macro-economic data being announced with alarming regularity is showing that the Indian economy is moving towards a new abyss. All the macro data has been quite dismal – contracting IIP figures, a depreciating rupee, increasing CAD, and worst of all, slower expected GDP growth – to list a few. Add to that a miserable June quarter financial performance of India Inc., and what you get is a sharp decline in the Sensex.

Not that a declining index is anything new, but it is the intensity of the fall which has left investors in the lurch. In the past five trading sessions, the Sensex has declined from the level of around 19400 to 18200. The drop on August 16, 2013 was the third-highest one-day fall in the last four years. The mayhem continued for the next two sessions, taking the index further lower. Especially in the backdrop of the 3.50 per cent up-move (which many looked upon as a revival) in the week preceding the fall, the street was caught off-guard.Investors are now pondering on what comes what next. While there is one lot which has got stuck at the higher levels and is desperately seeking advice, there is another lot waiting on the sidelines and seeks to know whether it is the right time to go ahead with bottom fishing. Here, we have discussed various factors affecting the future course of the indices and would try to get some concrete answers for our readers.

Depreciating Rupee: Still A Concern

If we look back, the single biggest factor affecting the investor sentiment is the depreciating rupee. Again, it is the intensity of the fall in rupee which is worrying the investors as well as India Inc. Hence, unless and until the rupee stabilises, one cannot expect investors to turn positive on the Indian equity markets. While the RBI has taken some reactive measures, it has not been able to attain its objective.

The main reason for this seems to be the nervousness of the US Fed tapering. Secondly, due to the revival in the US economy, many investors are taking a flight back to safety. The kind of selling that the Indian bond markets have witnessed over the past three months vindicates the same (See Chart: FII Activity In Indian Markets).

The moot question is – do we expect the rupee to recover? Unfortunately, the answer is not quite yet. We maintain our stance that the rupee will touch the levels of around 65 per USD following the exodus of FIIs from the Indian markets on account of the factors mentioned previously. Till date, FIIs have been net buyers in equities to the tune of Rs 65680 crore on a YTD basis. But if the dismal scenario persists, we may see an exit of FIIs from equities too, triggering another fall in the indices.

In this regard, Vinit Birla, Head of Research, Marwadi Group opines, “The current problem with the market is the twin deficits. Further, the depreciating rupee and rising bond yields are not supportive for FIIs to go long on the Indian markets”.

Dipen Shah, Sr. Vice President, Kotak Securities agrees saying, “On the rupee front, we don’t have any levels. But any significant depreciation of the rupee from the current levels is not expected”.[PAGE BREAK]

Earnings Downgrades: Another Negative

While the depreciating rupee has affected the sentiments, it has also affected the financial performance of India Inc., whose bottomline has taken a severe beating (For details, read our Special Report on the Q1 results analysis in this issue). The poor performance of India Inc. has resulted in many broking houses downgrading the FY14 and FY15 Sensex EPS estimates. This is a major negative, as though India Inc. had not been performing well over the past few quarters, there had been no downgrades so far. The consensus EPS estimate for FY14 now stand at Rs 1340-1350 from the earlier expectations of Rs 1475.

What is more worrisome is many have indicated that it may be revised downwards if issues like rupee depreciation and policy paralysis persist. According to a report by Emkay Global Financial Services, “While there may be values emerging, expected outflows from equities, continued contraction in earnings estimates, rising rates and prospects of a further decline in the INR will compress the multiples further”.

With the earnings downgrade, many have revised the yearly targets for the Sensex too. While Citi has revised the Sensex target to 18900 (from 20800), Morgan Stanley brought this to 19720 (from 20500-21000) and Nomura to 20000 (from 21700). We, at Dalal Street Investment Journal, would also like to revise our year end Sensex target of 22000 to the levels of 20250 (considering a forward P/E of 15x and EPS of Rs 1350).

Is It Time For Bottom Fishing Yet?

With the markets witnessing a significant decline in the past one month, investors would naturally be curious to know whether it is the right time for bottom fishing. Though it is not possible to time the markets, we feel that there is still some downside left.

Apart from the factors already mentioned, there are some other factors also emerging on the horizon. Principal among these is food inflation. While headline inflation is still below the RBI’s tolerance levels, food inflation has increased on account of supply-side constraints. As a result, the apex bank, which is already struggling on the rupee depreciation front, has another task on its plate. The RBI is thus, in a sort of Catch-22 situation. If it tightens money flows, growth would be hampered and if it provides liquidity, inflation would rise.

Apart from these macroeconomic factors, political paralysis is another worrisome issue. While there is a pressing need for real groundwork with regard to reforms, the UPA government is focusing on non-core issues like the Food Security Bill and defending itself in regard to various scams. There simply does not seem to be enough political will to fight back in the current situation.

A combination of factors like further depreciation in the rupee, rising inflation, worries on the twin deficit front and some selling by FIIs would take the markets further down. We expect another five to seven per cent decline from the current levels.

While it is true that there are likely to be sectoral opportunities, the opportunities here are fewer. On the sectors Dipen Shah says, "We are positive on the IT sector. We are selectively positive on FMCG, media and private banks. However, we remain very cautious on the infrastructure, capital goods and construction sectors. After the recent fall, we see some positive bias in select auto stocks".[PAGE BREAK]

Technical View

The Indian equity market has collapsed into a steep downtrend, and after correcting more than 10 per cent from the fresh high it made in the month of May, is now trading around the 5400 mark. The last month has been horrifying for the broader markets and major correction has been witnessed. The markets have broken their successive supports on the daily as well as weekly charts in the last two trading sessions, which stood in the range of 5470-5500 as defined by an upward rising trendline along with volumes. This suggests that the markets are in an intermediate and short-term downtrend. It is likely that this downfall may extend to the levels of 5170-5150.

We expect the markets to take some pause at this level. In fact, they may reverse from here as these levels are a very crucial support zone i.e. 61.8 per cent Fibonacci retracement from a high of 6229. If the Nifty breaks these levels of 5170-5150, the door for the 4750-4550 levels will be opened. On the upside, the market will face a hurdle around the 5550 levels, and if we sustain this level, we may see a pullback up to the levels of 5750.

Looking at current technical picture, it seems clear that we have shifted from a range-bound market to a short-term bear market. That means that we may see the prices drop further from here. We expect volatility to remain high through the quarter.

What Can Bring A Change?

What may change the scenario and sentiment in the market is some stabilisation in the rupee. Things may take a turn if the RBI, which will witness a change in leadership in September 2013, provides a proper gateway for the INR recovery. However, we need to see exactly what is different about the strategy the new Governor implements. Strong measures need to be announced on the policy front by the government rather than just lingering on the issues.

To summarise, we would say that the sentiment will probably get better if we see some reforms action from the government coupled with some policy changes by the RBI in terms of stepping back on some of the measures they had introduced in the past month and easing liquidity back into the system. Any early indications on the same would help the markets revive. However, till then we recommend that investors stay cautious and remain on the sidelines. A prudent strategy would be to sit on cash till the dust settles down. We are yet to reach the trough, and it would be dangerous to catch the falling knife as the velocity of the fall increases.