Currency woes, higher US yields may drag Nifty lower near term

On Friday, the Sensex closed at 26819, down 699 points and the Nifty closed at 8296, down 229 points.

A wide range of sectors are expected to see a sharp drop in business activity this quarter and probably even the next, as cash purchases/dealings get deferred. And it is the smaller businesses that will face the pain more than the larger firms. Hardest hit will be companies which cater to discretionary consumption.

Brokers say the mid and small cap indices may not reflect the full extent of the pain because the high weightage companies in these indices may be able to weather the demand slump and a slower payment cycle.

At the same time, even some of the large cap firms too are not immune to the expected contraction in economic activity.

A leading commercial vehicle player warned in a concall to analysts that sale of new trucks could be hit as many existing truck owners upgrade to a new vehicle by selling their old vehicles. And a substantial chunk of the trade in second hand vehicles takes place in cash.

Real estate is seen as the biggest casualty of the demonetization move, as secondary market transactions—with huge cash dealings—will come to a standstill for a while. The pressure is expected to feed into primary sales as well causing property prices to dip.

On the face of it, banks are expected to gain from the sudden rush for deposits—a lot of it to launder unaccounted money into legitimate income—as it will give them access to cheaper funds.

But as the latest quarterly numbers at State Bank of India show, the bad loan problem in the banking sector is quite significant.

Market players expect many companies to lower their earnings expectations for the current quarter, which could in turn put pressure on the stock prices.

The other major problem for emerging markets in general, India included, is that US bond yields have firmed up following Donald Trump’s victory in the US Presidential elections.

According to an article in cnbc.com, analysts see Trump's fiscal policies as leading to higher inflation which would attract inflows into the U.S. dollar and boost expectations that the Federal Reserve could raise interest rates soon.

A stronger dollar prompts many global fund managers to move a part of their funds away from risk assets like emerging markets, into US government bonds. India’s fundamentals are on a sound footing and the economic growth is much higher compared to other emerging markets. But the ripples of a broad-based sell off in emerging markets will be felt in Indian equities as well.

Foreign funds have net sold about Rs 4200 crore of Indian shares in the last three trading sessions.

Friday alone saw net selling of about Rs 2100 crore by FIIs according to provisional data on the stock exchanges. This has to be seen in the context of similar heavy selling in other Asian markets as well on that day.

“While such large foreign selling on a single day smacks of panic, we tend to use net foreign selling on a rolling 12-month basis as a sign of foreign investor capitulation,” wrote Credit Suisse strategist Sakthi Siva in a note to clients, adding, “..this time around, net foreign buying in Emerging Asia excluding China and Malaysia is still running at 0.5 percent of market cap.”