by Manas/ BWI
On 9 August, the BSE Sensex closed at 11,145.18, its highest closing since 18 May. The markets have risen sharply in recent days, with the Sensex gaining 10.5 per cent from its 21 July low. Moreover, the rally has been broad-based, with the BSE Midcap index rising 12 per cent from its 24 July low and the BSE Small Cap index gaining 13.2 per cent from that date. Is this rally for real?
It’s not only the Indian equity market that is rallying. Most emerging markets indices are solidly in the black this quarter and, as of 8 August, the MSCI BRIC Index was up 4.2 per cent.
The biggest reason for that is the US Fed’s pause in its two-year campaign to hike interest rates. In the second quarter, growth has slowed in the US and the housing sector is looking particularly weak — an indication that hikes have started hitting home. The markets are celebrating in the hope that the US interest rate cycle has turned down. US 10-year bond yield is now below 5 per cent.
But will the slower growth hurt earnings and stocks? The markets are betting that the Fed will be able to engineer a soft landing. This will mean a continuation of the global “Goldilocks economy”, the not-too-hot, not-too-cold scenario that has been so good for stocks in the last three years, and will be so for emerging market equities too. Also, with the dollar looking vulnerable now that the rate hikes are on hold, the case for investing in non-dollar assets is stronger. The IMF too sees a soft landing for the US, “with growth easing to potential and inflation remaining contained”.
Back home, good corporate results and the return of FII buying have bolstered sentiment. But if volumes are an indicator, conviction in this rally has been lacking. (The market turnover on 8 August, when the Sensex crossed 11,000 just before the Fed meeting, was the lowest this year.) This is also the case in the overseas markets. The Dow has been range bound. The problem is that the Fed has said it may raise rates again later if inflation is not curbed. With oil prices showing no signs of easing, some have started warning of stagflation.
The EU and the UK have already hiked rates. Japan continues to go from strength to strength. In short, global liquidity is likely to tighten for further. That will hurt emer- ging markets. A recent Deutsche Bank Industry Strategy paper from Japan points out the similarities between the emerging markets bubble and the IT bubble of 1999-2000. It says there is always a rebound from the lows after the initial crash. For instance, while the peak of the IT bubble was in April 2000, the ensuring rebound peaked in September 2000 and the bottom was reached in October 2002. This time, they expect the emerging markets to hit bottom in August-October 2008, with the current rebound doomed to fail.
Not everyone will share this pessimism. India’s growth remains strong and the Fed’s pause will make a case for a pause by the RBI as well. But it is likely to be a while before Goldilocks is back.