Devangshu Datta: Optimism tempered with caution

Despite the logjam in Parliament and negative signals from abroad, India could become the fastest-growing of large economies this fiscal

Corporate earnings trends, a collapse in global commodity prices, prospects of parliamentary logjam and the implications of the draft Indian Financial Code are among the factors influencing sentiment on Dalal Street as the July settlement approaches.

The undertone seems optimistic. Breadth continues to be good and it looks as though midcaps will outperform the Sensex-Nifty basket. The indices climbed, even though the changes weren't too large.

So far, India's Q1 results have been around par, though admittedly expectations weren't high. Infosys made the market very happy due to strong quarter-on-quarter revenue growth, despite low profit growth year-on-year (and profit reduction quarter-on-quarter). Hindustan Unilever (HUL) disappointed due to anaemic growth; in fact, it was sold down.

HDFC Bank hit consensus estimates, with one nasty surprise in that provisions for non-performing assets shot up. Reliance registered higher refining margins but lower topline, as expected. Sun Pharma has taken a beating because of continuing issues related to the Ranbaxy merger. Lupin also fell on lower sales guidance for the second half. Asian Paints had an excellent first quarter, while Cairn and ACC took a hit.

News from abroad has been confusing, and somewhat skewed towards the negative. China seems to have stemmed the rot in terms of falling stock index levels. But there are fears about ballooning corporate debt (above 160 per cent of Chinese gross domestic product by most estimates). There has also been continued selling in commodities, including base metals, on the assumption of a Chinese growth slowdown.

Last week saw huge quantities of gold being unloaded on Chinese bourses. It smelled like forced unwinding - either the selling of collateral on losing stock positions, or the selling off of leveraged positions in the precious metal itself. Gold is now down to five-year lows and it could drop lower, if central banks release some of their bullion reserves.

Speaking of central banks, the draft Indian Financial Code could rile markets, if it goes through. Bluntly, Reserve Bank of India (RBI) Governor Raghuram Rajan has a lot of credibility, domestically and abroad, and removing his veto will cause perception issues.

The policy review on August 4 will be awaited with interest because it may articulate the RBI attitude with some clarity. Consensus expectations narrowly rule out a rate cut and now some bears are speculating about possible hikes in 2016 if food inflation doesn't ease down. The other volatile element in the inflation basket - fuel - is likely to stay down, given falling crude prices.

The monsoon will not just influence food prices; it will be crucial for growth in the second half of the fiscal. There are multiple signs of poor rural demand such as HUL's results, low tractor sales, low demand for gold etc. Consumption cannot drive growth without a pickup in rural demand and rural demand will not rise without a better harvest.

In America, there's disappointment about the Fortune 500 results. Apple's sales growth was below consensus, Microsoft registered a big loss and Caterpillar and Amex were also down. Biotech has take a hammering as a sector. Overall, key indices like the Dow Jones Industrial Averages and the Nasdaq lost ground.

In the meantime, the US dollar continued to harden on rumours that the Fed Reserve is now looking at a possible third-quarter (July-September) hike. The leak of internal Fed forecasts of a rising rate has added to the tension. Rate hikes are also anticipated in the UK.

If Parliament remains jammed through the monsoon session, hopes of legislation enabling further reform being pushed through, will fade. The timeline for passage of the Goods and Services Tax Bill is uncertain. The actual implementation looks set for further delays and it is likely to miss the April 2016 deadline. Labour laws and of course, the land acquisition amendment also remain stuck.

Nevertheless, India will, in comparative terms, be the fastest-growing and least troubled of large emerging economies in 2015-16. That is one reason why foreign institutional investment (FII) flows are positive in July (after being net negative between April-June). Of course, FIIs could pull back if there is a serious investigation of P-Notes, as is now feared.

Technically, the Nifty is holding ground above its own 200-Day Moving Average. There has been range trading for the past few sessions. Barring some major shock, this could continue until the August settlement launches. One worry is that an index PE of 23-plus is historically high and it's difficult to justify yet another quarter of low growth.

But under such circumstances, the best thing a trader can do is sit on his/her hands and wait for a trend to develop. The RBI policy review may just set off a trend, if there's a rate cut, or the speech is overly bearish in tone.