RBI move spells bad news for equity mkts

The world has changed quite a bit over the last few last hours. The RBI has pressed the rate trigger, the repo rate is up 50 bps and CRR is up 50 bps in two tranches and that becomes the big trigger for the market this morning.

Global markets are almost inconsequential. Crude is still hovering at around USD 137/bbl, so no change in status there. Today it’s all about interest rates and how the economy and the equity markets will deal with it. We are not starting off on a good note. The only question is if we have a big knee jerk reaction on the way down, where do we go from there. The start should be bad because this is a very sharp interest rate hike.

I am not sure whether the entire quantum was expected so soon. I don’t think a 50 bps repo rate hike and a 50 bps CRR hike was expected in the price in any case. So this is a sharper then expected rate hike and there should be a knee jerk reaction. There might be technical adjustments after the initial gap down but that is a trading move.

I don’t think the RBI is done completely yet. They may not move till the next meeting in July but we are done for 2008. This is bad news for the equity markets; growth will slowdown and interest rates will have to go up. It certainly vitiates the economic and the stock market environment. It opens up the possibility of further PE contraction as well. So if you look at it from the rate sensitive or from the economy or the stock market at large, this is not good news and we will have to deal with it today.

Q: And the mood was brittle up until yesterday. Will this be a huge male in the coffin?

A: Yes, we will fall this morning. The jury is out on whether after the initial cut there will be some kind of short covering. This is entirely possible because the fall has been sharp and after today morning’s fall it will get even sharper. So if we get pegged back to something close to 4,000 on the Nifty, if we go a few points above that then I think from those levels there might be an attempt to claw back once again. I don’t know whether that will be a successful attempt but that might happen. In the medium-term I think the headwinds are only getting stronger against the equity market.

 I think we need to keep our fingers crossed be practical and pragmatic about what is going on in the environment and not just cling to some technical levels and wish things will improve. That’s not how markets typically behave. So we are in a difficult situation. We will open gap down, where we go from there is debatable, but in the medium-term I think the equity market outlook looks quite challenging.

Q: Give us one word on the rate hike impact for our own market?

A: It’s not just the market. I think the bigger problem is the economy right now because I do not think global investors will like what is going on out here. We are already staring at a fairly significant slowdown in economic growth. This will translate into a lower earnings growth eventually. I do not know about this current quarter where the advance tax numbers are good. So people are taking a lot of heart from that but that is history. I think the market is looking forward but it’s not a very good picture at all. I heard a lot of public sector bankers say that they will not raise rates, I think they are living in dream. Rates have to go up in the system. Now whether it is 50 bps for the moment or it is 1% point over a period of time that I think is a debate

The bigger problem is that the Reserve Bank of India (RBI) may not be done yet. But the RBI may not make a move till July. So, there may not much by way of uncertainty, for the next few weeks as the market digests this current round of rate hikes. But beyond that the inflation may not cool down and the longer the inflation stays at double digits 10-11-12%, the more will be the political pressure.

Just look at what the RBI has been doing. Dr Reddy had a meeting with the FM and the PM. He came back and announced saying things are good, demand supply evenly matched. He said he would only take measures at appropriate times. Then within 48 hours comes the 50 bps repo rate hike plus a 50 bps CRR hike. I think we should read the action and not the words, which are coming in from the Central Bank right now.

There will probably be more rate hikes because inflation is not going to cool down over the next week or the next month. If steel prices go up, which looks quite inevitable, you will see more inflation fires being stoked in the system unless they are beaten down.

So we are in a bad commodity situation, which means we will remain in a sticky inflation situation for some time and that might make the RBI move again. So we have probably started after March last year when we did not see any more repo rate hikes only CRR hikes. In June we probably started another leg of the move up on the interest rates and that might well continue and that is the big problem for the market and for the economy.

You now need to go back and see what will happen to growth and what will happen to PE multiples in the equity market if interest rates heads even higher from here. We have already talked about 8.8-8.5%. If we go to more than 9% over the next few weeks and months, I think we will have a big problem with equity valuations as well.

It is a tough situation and there are no other words to describe it. It is probably not even done yet. So today I do not know how it will react, maybe a fall and then a bounce. Longer-term I think we are setting ourselves for deeper problems going forward, which may not be just for the next quarter or for the next half of the year. There might be longer-term damage, which we are setting ourselves for with every passing interest rate hike.

Q: The big damage that happened yesterday, the market has got a big short cushion going but what does one expect from the Nifty?

A: Two things could happen depending on whether you are approaching the market from a trading perspective or from a slightly longer-term perspective. If the Nifty falls this morning by say 100-150 points and gets closer to something like 4,000-4,050, at that point the first line of support comes in at psychological 4,000 or technical levels of 4,050. From those levels the bears might book some profits. There might be a lingering feeling that the bad news has been priced in and therefore there could be a pullback maybe to 4,200 kind of levels that might lead to an allusion that a panic bottom has been hit and we are out of the woods.

Remember, at 4,400 and before that at 4,800 talk went around in the market that this is the bottom, which has been formed and all the bad news is in the price. I think the bad news cannot be in the price because the bad news has not started manifesting itself in earnings and in economic growth slowdown yet. We are still growing very fast as an economy. According to the last reported numbers, we are still doing great with earnings and this may well be the case for the next quarter. Beyond that when the bad news actually starts coming in, I think the markets will have to factor it in