Despite taper fears, election uncertainties, market should stay range-bound

The past four to six weeks have seen market operators adjusting to the new paradigm of a taper. Between September 2012 and December 2013, the US Federal Reserve expanded its balance sheet by $85 billion a month. This means it was buying assets in various markets and releasing liquid cash, which mostly flowed into various financial assets.

The Fed has now cutback the expansion to $65 billion a month and intends to slowly reduce the expansion over the next 10-12 months. Last week, traders in the US celebrated because the January employment record was unexpectedly weak. Hence, the pace of the taper might decelerate. At the same time, the Chinese central bank has indulged in a much larger expansion of balance sheet and the Bank of Japan (BoJ) has also put out $80 billion a month. Neither the Chinese nor the Japanese will necessarily slow their quantitative easing (QE) programmes. There is also a chance the European Central Bank will loosen up.

However, the liquidity released by the BoJ or the Chinese expansion is likely to move into assets other than global equity. So the Fed's tapering has already had a bearish effect. The impact has mostly been felt in emerging markets where there have been massive outflows of capital.

These outflows can also be fundamentally justified. As things stand, India and Indonesia are headed for elections, which mean great political uncertainty. Turkey has political instability and a burgeoning currency issue. Growth is weak in China, Brazil and South Africa and in India as well. In contrast, growth is picking up in First World economies. The US is in the middle of a GDP expansion, which seems sustainable. Eurozone seems to have put the worst behind it. The UK appears to be pulling out of a recession. Japan is also showing signs of greater economic activity. It would be natural for global investor to seek returns from these markets through the next several quarters.

India could see a rebound in inflows if the election results are perceived as positive. It is extremely unlikely that there will be much in the way of overseas interest in Indian equity until the shape of the next government is known. It is equally true that India could see a stampede for the exit if the election results are not perceived as positive.

The probability of an entirely stable government being installed is very slim. Most investors seem to be hoping for a strong showing by the BJP and an NDA coalition that logs 272-plus seats. The opinion polls do suggest that the BJP will be the single largest party by a distance but also that it will be well short of a majority on its own.

Of course, this could change over the next three months and it will - but we have no idea in which direction voting trends could swing. India's first past the post system with its multi-cornered contests is always extremely tough to call.

This could mean the usual give and take of horse-trading and an NDA-led coalition that is not in a position to make substantive changes. It is also possible that the BJP will be unable to put together a government at all, even if it does have a strong showing. That would leave a mess as in 1998, with every party that holds 20-odd seats bargaining for a large slice of the pie.

Under the circumstances, a trader could fish in troubled waters through the next three-four months. Political newsflow could mean sudden shifts in trend and violent intra-day swings. But long-term trends will not be established until the next government is in place. It's extremely unlikely that there will be meaningful inflows at the moment and also true that nobody will completely abandon the market at least until the elections are over. That could mean the range trading patterns we've seen over the past six weeks will continue, one way or another through the next three settlements.