Volatility is a constant feature of the market. There will always be tailwinds pushing the market up and headwinds pulling it back. During a market rally, the tailwinds will be stronger; during a bear phase, headwinds will be stronger. When tailwinds and headwinds are balanced, the market will consolidate in a range.
Which are the tailwinds and headwinds influencing the market now?
The sharp 18 percent rally in the Nifty from the low levels of March has been driven by global and domestic tailwinds. The US economy’s soft-landing narrative triggered a rally in the mother market US, and this lifted markets, globally. The softening US bond yields and declining dollar facilitated capital flows to emerging markets like India, which further helped the rally to sustain. Back home in India, the economy moved to a sweet spot helping the rally gather momentum. India’s consistently improving macroeconomic fundamentals – highest gross domestic product (GDP) growth among the large economies of the world, declining current account deficit (CAD) and FD, the banking sector in the pink of health and deleveraged corporate sector – turned out to be strong tailwinds that helped the rally sustain and reach within kissing distance of the 20,000 Nifty mark. At this stage, some headwinds are emerging.
A strong tailwind that helped the rally has been the strong Foreign Portfolio Investment (FPI) flows during May, June, and July. FPIs had invested a cumulative Rs 1,37,603 crores in the Indian market during this 3-month period facilitated by the declining dollar and falling bond yields in the US. This trend has weakened considerably in August and FPIs have turned net sellers in the cash market. The rise in the dollar index which had fallen below 100 in July to above 103 by mid-August and the sharp spike in US bond yields pushing the 10-year yield above 4.25 percent have turned out to be headwinds for FPI flows. The high valuations in the market ( one year forward PE of around 20) gave ammunition to bears.
The domestic macro scenario suffered a jolt with July consumer price index (CPI) inflation spiking beyond consensus estimates to 7.44 percent from 4.8 percent in June. Even though the villain of the inflation drama was the 37.5 percent rise in vegetable inflation, the prices of cereals and pulses also rose by 11. 5 percent rendering inflation management tough. The takeaway from the high inflation is that the Monetary Policy Committee (MPC) will be forced to keep rates higher for longer. From the market perspective, the concern is that a rate cut which the market expected by early 2024 has been pushed back to around mid 2024. This has turned out to be a strong headwind for the market. Another area of concern is the poor monsoon in August, particularly its poor spatial distribution. If the monsoon doesn’t revive, inflation may even aggravate and headwinds for the economy may get stronger.
The scenario may change quickly. So, watch out for the crucial macro numbers.
Long-term investors should be focussed on the India Growth Story which is getting better and better. India was the 10th largest economy in the world in 2013; now we are the 5th largest and projected to be the 3rd largest by 2027-28. An $8 trillion economy with a $10 trillion in market cap is achievable for India by 2032. In brief, the wealth creation through the stock market during the next ten years will be unprecedented and phenomenal. Investors need to follow a simple investment strategy to benefit from this potential wealth creation: Invest systematically and wait patiently.