Green signals in stock market

Green signals in stock market

The stock market has recovered sharply in recent weeks, thanks to funds pouring in from foreign institutional investors (FIIs). Nobody predicted such a rapid rebound. The inflows come at a time when oil prices have moved up rapidly, inflation has been persistent and several economists have forecast lower growth in FY12. Is the market, which is supposed to be forward-looking, seeing a change in these factors?

In November, when foreign funds pulled out of emerging markets (EMs), the reason given was that the prospects of a recovery had improved in the US economy, while emerging markets, beset by inflation, would see slower growth. That set off a bull run in US equities. Strangely, given Europe’s well-known fiscal problems, the European bourses too improved significantly. This Sell EM/Buy DM trade was the rage between November and February. Since then there has been a change in trend with both developed and emerging markets moving up, but the latter has outperformed.

One of the reasons given for the switch is that developed markets (DMs) are no longer so attractive now that inflation is spilling into them. The European Central Bank on Thursday tightened its main interest rate. In the US, the end of quantitative easing is causing some apprehension. On the other hand, the market contended that emerging economies are nearing the end of their rate tightening cycles, hence the balance of forces is again in their favour.

These generalizations need to be taken with a pinch of salt. It’s doubtful whether anyone has been able to predict oil prices correctly. High prices are clearly a negative for oil-importing markets such as India. Likewise, everybody believes that the Reserve Bank of India has to do some more tightening to tame inflation. And if growth does surprise on the upside, surely that will induce the central bank to tighten even more?

Perhaps we are reading too much into the ebb and flow of FII money. All that Indian and other emerging markets have had is a much-needed correction. Indeed, the correction in the Sensex has been shallower now than during the pullback in early 2004 and in May 2006 during the last bull run. Valuations had run up too rapidly, leading to profit-booking. When positions had been pared and valuations were down to reasonable levels, it was time for a rotation back to emerging markets, including India. Ultra-loose monetary policy in the West has led to hot money moving in and out rapidly among various asset classes, and emerging markets are no exception.

What matters far more is the guidance that companies give for FY12. That will provide a much deeper insight into the prospects for growth.

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