Jan 9, 2012

Subbarao hints at easier policy. Why did markets not rally?

The RBI Governor, D Subbaroa, hinted at an easier monetary policy (see ET article on 6th Jan). The rate cycle turning will be positive for the economy and markets. Why did the markets not rally then? I think stagnancy in the markets is related to uncertainty about the date of rate cuts compounded by the risks posed by the earnings season.

The state of public finances is not exactly where the government wants, or the market expected. The government has overshot its fiscal targets and agencies like NHAI are making large bond offerings with more paper expected down the line. The prevailing sentiment is that the markets will not be able to absorb so much lending at lower rates and that the RBI, as the de facto debt management office of the government, will try to auction G-sec first and cut rates later. Essentially, this implies that rate cuts will not happen on the Jan 24 meeting but at some date after that.

To add to uncertainty related to the date of a rate cut, there are quite a few corporate earnings which will be announced in the two weeks leading up to the monetary policy meeting on the Jan 24. There is a fair degree of unease in the markets about corporate profits, bank asset quality, order book growth in infrastructure, regulation and scam in telecom, etc.

If you buy the markets today, and there are negative shocks to earnings between now and the policy, you don't really make any money. If the policy is good, you simply recover the intermediate loss. If they do not ease, well, then you lose some more. The compounded probability makes buying the market an unattractive proposition for risk averse traders.

Chances of a negative surprises for the dominant part of the NIFTY are low. The sectors with the highest weights in the NIFTY - financials (26%), energy and related (15%), pharmaceuticals (4%), software (14%), infra related (more than 5%) - have a small chance of further negative surprises with expectations already being very low, though IT can be complicated with the impact of the rupee still not known clearly. I think that there are low chances that the rate cuts will be deferred beyond the Jan 24 meeting - there is too much at risk for the government and the economy to be stupid about monetary policy any further.

This is a time to go long without leverage on quality large cap stocks which are oversold. Public sector financials and infrastructure stocks like Larsen and BHEL look good. Select midcaps like Biocon look very attractive as well.

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