The Reserve Bank of India’s monetary tightening has had no effect on the stock market so far. The market seems to be unconcerned about the cost of funds going up. One explanation could be that the market feels the tightening is temporary, as the government has been repeating ad nauseam. Also, the stocks that have gone up the most aren’t really affected by higher interest rates.
The other, and more likely, reason is that it’s the Ben Bernanke effect, with the US Federal Reserve chief’s latest pronouncements having a soothing effect and investors now believing that the tapering of the Fed’s bond buying programme will be delayed on account of the weakness of the US economy. As a result, while the bulk of the fund flow is still towards developed markets, data from funds-tracker EPFR Global show that emerging markets have started seeing slight inflows into equities.
Analysts point out that the divergence between the performance of developed country stocks and emerging market stocks has led to lower valuations for the latter, making them more attractive. For instance, the Sensex now may be around the same level as it was in January 2011, but the past price to earnings multiple is lower.
The Bank of America-Merrill Lynch fund manager survey for July says that the “combination of a collapse in China growth expectations and record US dollar bullishness sent EM (emerging markets) equity exposure within a global portfolio down to its lowest level since 2001”. Profit expectations in emerging markets have fallen to their lowest level on record, according to the survey. Bullish sentiment on the US dollar also reached a record level. EM fund manager weights to materials, Brazil and South Africa are all at record lows. Since the survey is usually seen as a contrarian indicator, it could be the signal both for dollar weakness in the future as well as an indicator of a turnaround in emerging markets. In short, the combination of dovish noises by Bernanke as well as the low levels of exposure by fund managers is supporting emerging market equities at present.
It’s also worth noting that in spite of the falling rupee, the central bank’s tightening measures and looming political uncertainty, MSCI India has outperformed almost all emerging market indices in July as well as in the past three months.
It’s likely that the monetary tightening measures will continue. There are no signs of any improvement in the economy and political uncertainty will persist, underlining the stark divergence between the markets and the economic fundamentals.