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Does Fed's rate-hike signal mean end to liquidity-driven rally? Here's how to plan your next move

Fed's recent announcements may not trigger a knee-jerk reaction as there are comforting points such as falling COVID cases and easing of restrictions but a mild correction is a strong possibility, say experts.

June 18, 2021 / 11:35 AM IST

The US Federal Reserve has signalled it was getting ready for at least two rate hikes by the end of 2023 and also started discussing ways to taper monthly bond purchases.

The Fed on June 16 said the US economy was well on track to recovery and expects the economy to grow 7 percent this year.

The announcements drew expected responses from the market. The benchmark Sensex ended with a loss of 0.34 percent on June 17, while the rupee ended 76 paise lower at 74.08 a dollar.

When the coronavirus pandemic hit the world, central banks came to rescue of the markets by infusing massive liquidity by applying all tools available to them such as bond-buying. Key lending rates were lowered sharply and other measures taken to keep the market and economy aloft.

The steps worked. Major markets witnessed strong gains. Indian benchmarks the Sensex and the Nifty hit record highs even as the economy was still showing signs of acute pain.

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This was clearly a liquidity-driven rally. There were other factors too, such as the boom in retail investors and a drop in COVID-19 cases but primarily, the market remained high on the doses of liquidity and

assurance from central banks that the flow will not be tapered anytime soon.

Also read: US Fed meet, rising US dollar and its implications on emerging markets like India

What now?

Lately, rising inflation is making investors nervous, fanning fears that it may get difficult for central banks to keep the stance dovish.

Fed's signal may not trigger a knee-jerk reaction in the market as there are comforting points such as falling COVID cases and easing of restrictions but a mild correction is a strong possibility.

"With Fed signalling rate hikes in the future, liquidity flow will be affected and markets may see some correction in due course," said Nitin Shahi, executive director of FINDOC.

However, the correction may be a short-term event as investors will ultimately focus on other factors such as economic indicators and corporate earnings.

"Currently, the market is trading at all-time highs and correction is due but long-term investors will be willing to invest in the growth story of India. In the long-term scenario, fund flows are of no concern but investors should analyse and invest in stocks with strong fundamentals," Shahi said.

Vishal Balabhadurni, Senior Research Analyst, CapitalVia Global Research, agrees that the market may see a correction in the short term.

"The US Fed officials predict that with the vaccination drive spreading of COVID has been contained, and is also expected that unemployment rate will come down despite short-term weakness. This indication clearly

suggests the era of liquidity driven markets will come to halt in near future," Balabhadurni said.

Shrikant Chouhan, Executive Vice President, Equity Technical Research, Kotak Securities, said the rally started mainly due to liquidity but the injection of liquidity has been in the right place.

"The current rally is run on demand. This market may correct in the short-term but the intermediate trend is very strong and value-buying could take place in a big way at major supports," Chouhan said.

As the US Fed has hinted it would consider tapering bond buying, investors globally will now start to speculate as to when the bond buying will be cut or abandoned.

Deepak Jasani, Head of Retail Research, HDFC Securities, said when the Fed would begin to cut bond-buying, interest rate rise could gain momentum globally. Till that time, the hitherto seen unabated flows from abroad into different global markets, including emerging markets could slow.

However, Jasani said, if global investors expect returns from a market that are more than the total borrowing rate and currency hedge costs, they will anyway come and invest.

"So the difference now is, some more diligence by foreign investors may be witnessed before they invest overseas. In India, so far, we have seen robust retail and HNI flows and to some extent, liquidity is being provided by them. A sustainable downtrend in our markets could, however, result in reversal of these local flows," said Jasani.

How should you prepare for an ebb in the market?

A market correction is the opportunity to add quality stocks to your portfolio.

"Liquidity issues have no impact on quality stocks and one should have a strong conviction in quality stocks when the market falls," Shahi said.

Jasani said investors will have to be more selective from now on and move up the quality ladder.

"Penny stocks and stocks that are moving up on random tips or expectations without any visible improvement in performance are best avoided. If investor's asset allocation has tilted towards equities due to the rally in equity markets, it may be time to reduce equity exposure by taking profits and restoring the originally planned allocation," said Jasani.

Balabhadurni said the last few periods have been going on with a low-interest rate economy and therefore liquidity has been rampant. This has led to a rise in inflation and the inflation risk is real, therefore, investors must be careful while picking stocks or instruments and factor into this aspect also.

The more permanent solution to battle inflation is increasing the rates, therefore investors must be prepared for this as the economy recovers, he said.

As per Chouhan, the strategy should be to reduce weak long positions or reduce exposure of those sectors where the concentration is very high. However, investors should be equally prepared to buy on major declines. The next move should be in smallcap stocks, said Chouhan.

Disclaimer: The views and investment tips expressed by experts on Moneycontrol.com are their own and not those of the website or its management. Moneycontrol.com advises users to check with certified experts before taking any investment decisions.
Nishant Kumar
first published: Jun 18, 2021 11:34 am

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