Short Call | Focus stays on Nifty support levels, China gloom deepens, and a hawkish Fed

markets

Bulls are low on morale heading into expiry week, but the more hopeful are betting on short covering to provide a floor. Profit-booking seems to be catching up with second line shares as well, though it is early to call a trend. In the meantime, traders are closely watching the crucial 19300 support level on the Nifty.

What companies are saying

NRI investment is a trend but there is not a big demand coming from them.  SEZ commercial demand is seeing pressure across the country as companies have been delaying decision to rent properties in SEZs.

Average realisation prices have declined in the chemical space, but demand in textile segment is improving.

Will see double-digit revenue  growth in second half of this year, but revenue growth for the year as a whole will be flattish. Exports have slowed down dramatically, and will be somewhere  between 5-10 percent for this year.

Q1 Takeaway

BSE-500 companies witnessed 7.2 percent revenue growth but 46 percent

growth in net profit during the June quarter, according to a report by Kotak Institutional Equities. Margin recovery was sharp thanks to softening of raw material prices, with average EBITDA (earnings before interest, taxes, depreciation and amortisation) hitting a a seven-quarter high of 16.4 percent.

And yet, consensus EPS for BSE-500 companies for FY2024 and FY2025 have been broadly stable through the 1QFY24 results season, despite the sharp increase in net income of the BSE-500 universe, observe the Kotak analysts.

Why?

“We assume the reported results and management commentary did not add much to the extant high expectations,” says the Kotak report

Not a bad thing at all, given that promoters of mid and small cap companies are usually known to build up unrealistic expectations among investors.

China gloom

More bad news coming out of China. Profits at China’s industrial firms fell 6.7 percent in July compared to the same period last year. This is the seventh straight month of declining profits as demand continues to remain weak. For the seven months ended July, profits are down 15.5 percent year-on-year.

Conflicting signals

Iron ore resumed its rally in Singapore on Friday, posting biggest weekly gain in 11 weeks, as market is counting on policy support for China’s faltering economy, says a Reuters report. Support for iron ore was intact despite a Mysteel consultancy note saying some mills in China’s steelmaking hub of Tangshan city have suspended sintering operation for one week from Aug. 24 as required to improve air quality, the report added.

Isolated problem

Downside risks are growing in China’s economy, write T.Rowe Price analysts. The recent spate of negative news coming from China’s property and trust sectors threaten to create a vicious cycle creating more problems for the country’s beleaguered economy.

However, the risks of a systemic crisis emanating from China’s property sector appear low, says the Rowe Price weekly market commentary note.

From the note:

“The riskier “shadow” banking system, which includes trusts, is smaller today than it has been in recent years thanks to increased regulation. As a result, our analysts believe that the key risks are at the periphery of its financial system and potentially resolvable through regulatory intervention.”

A different perspective

The big story in global financial markets is not an impending implosion in the Chinese economy, but it is the meltdown in US Treasuries, writes Louis-Vincent Gave of Gavekal Research in his report titled ‘Making sense of the China meltdown’.  US bond prices fell around 9 percent in August as yields surged despite there being no major negative news. On the other hand, key technical charts in China—banks, equities, government bond yields, consumer spending, commodities—are not reflecting a crisis point despite the sea of bad news all around.

From the report:

“This is odd. Why are US treasury yields rising when the Chinese news is so bad? Then it struck me that perhaps I had things the wrong way round and that I ought to be asking: Is the Chinese news so bad precisely because US treasuries are melting down.

A Chinese meltdown, reminiscent of the 1997 Asian crisis, would be just what the doctor ordered for an ailing US treasury market: a global deflationary shock that would unleash a new surge of demand and a “safety bid” for US treasuries”

Why take Gave seriously? Well, one good reason is that he was among the handful of economists who in December 2020 had warned that market was underestimating the risks from an imminent surge in inflation. His words turned out to be prescient.

Dove in hawk’s clothing

US shares rallied on Friday despite the Fed reiterating its warning at the Jackson Hole Symposium that it would keep rates higher for longer. The market feels it could be an empty threat and the Fed is actually done with hiking rates.

So why the hawkish commentary then?

Justin Lahart writes in WSJ:

“As soon as the Fed says it probably won’t raise rates again, investors’ focus will quickly shift to when the Fed might start cutting. If they do that, long-term interest rates in particular might start sliding, providing a fresh boost to the economy that policy makers aren’t quite ready for.”

By leaving open the possibility of rate hikes in future, however vague, the Fed appears to be trying to dissuade the market from building up a scenario where the central bank may cut rates rapidly.

Slower gains

Things are not looking great for US equities, according to an Edward Jones weekly newsletter.

From the newsletter:

“We don't think that consumers are tapped out, but the recent pace of growth and strong demand should not be extrapolated into the future. Credit conditions continue to tighten, job gains are gradually slowing, and the Fed's rate hikes tend to work with long lags

Without a quick Fed pivot to rate cuts, valuations might have a hard time expanding further. This implies that even though the foundation for a sustainable uptrend in equities might have been formed, the pace of gains will likely slow.”