Softening US bond yield is a bullish signal. State election results are significant

UB Bond yeild
US dollar hologram on the background of the financial chart. Economy concept, business investment, economic crisis, decline in profits, recession. mixed media

This is the age of polycrises and heightened uncertainty. Two wars are raging in the world, and nobody has a crystal ball to see how these will end. But geopolitical issues, as of now, are unlikely to impact the market significantly. So, let’s try to learn from the market signals and discern the method in the madness.

The market is climbing all walls of worries

After the crash triggered by the outbreak of Covid-19 which took the Nifty to 7,511 in March 2020, the market staged a rally which has taken the Nifty to around 19,700 level now. In spite of two wars and a sluggish global economy, the market is resilient. The ability of the market to climb all walls of worries is the sign of a bull market. It is important to keep this in mind.

Softening US bond yield is a bullish signal

Globally markets are highly correlated; the mother market US sets the trend. Equity markets are always impacted by rising interest rates. As Warren Buffet famously said, “interest rates are to asset prices like gravity is to apple”. The super strong US economy and inflation ruling higher than the central bank’s target rate had forced the Fed to maintain a hawkish stance. The market had factored in a ‘higher for longer rate regime’. The benchmark US 10-year bond yield spiked to 5 percent in mid-October. Attractive US bond yields triggered sustained selling by Foreign Portfolio Investments (FPIs) in India.

US inflation is cooling off better than expected

The US retail inflation declined better-than-expected in October to 3.2 percent. More important, the MoM core inflation is up a mere 0.2 percent. Now it can safely be assumed that the Fed is done with rate hikes and the expected rate cuts in 2024 is likely to be advanced. FPIs are likely to reduce their selling and may even turn buyers, lest they miss out on the potential boom in the best performing large economy in the world.

Even if the Foreign Institutional Investors (FIIs) continue to sell, the markets will rally. The influence of FIIs have declined significantly and Domestic Institutional Investors (DIIs) and retail investors are calling the shots now. This is the reason why, despite FPI selling, the market has been resilient.

India’s strong macros will support market resilience

Global growth is sluggish, and foreign investors will continue to chase growth. India’s GDP growth at around 6.5 percent in FY24 will be the best in the world. The growth momentum in the economy is strong. The best indicator of the growth momentum is the impressive credit growth in the economy running at around 17 percent. This red-hot credit growth has persuaded the RBI to flag potential risk to macro financial stability. The RBI decision to raise the risk weight on unsecured loans by 25 bp to 125 percent has been necessitated by the robust domestic demand and the consequent high credit growth.

Read Geopolitical headwinds usually pass without major market impact

The CPI inflation trend continues to decline. The inflation print came at 4.87 percent in October from 5.02 percent in September. This declining trend will enable the Monetary Policy Committee to continue with the rate pause and go for rate cuts in 2024. An area of concern is the rising trade deficit triggered by the sharp spurt in imports in October. The merchandise trade deficit rose to $31.46 billion in October from $19.4 billion in September. This, along with FPI selling has weakened the rupee to around 83.30 to the dollar.

Market rally in the run up to elections?

Going forward, political developments will influence market trends. This is the season of elections. Watch out for the state elections results which can be indicative of the General elections results in May 2024. The market behaviour during the last five General elections is important. Markets rallied in the run up to the elections. The rallies started around 6 months before the elections, and the returns ranged between 3.1 to 30.4 percent. It is important to understand that the rally begins in the run up to the elections, not after the results. After the results, the reaction will be sharp, only if the results are totally unexpected, like in 2009.

If the geopolitical issues do not aggravate, a rally in the market is likely after the State elections. If the exit polls after the elections indicate political stability after the General elections expected on May 24, a sustained rally is likely. So, watch out for the political space.

Sustained FPI selling has been weighing on financials, particularly the leading large banks. The banking sector is doing well; the results are good; the prospects are bright; and more importantly, the valuations are attractive. Large cap banking stocks will bounce back. This is an opportunity for patient investors. Weak Chinese growth will weigh on the prospects for commodities.

Automobiles and capital goods are in cyclical growth stage. Real estate is doing well. The profitability of the cement segment is improving. Digital platform companies have a long runway of growth ahead of them. Remain invested in this volatile bull market and continue with systematic investment.

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