Will this rally last?

As the economy gets into the quarterly results season, the question is whether this rally has still got legs, or whether it will now run out of steam

The Sensex is now up more than 35 per cent from its low point, and what most observers (including this newspaper) categorised in mid-March as a bear-market rally has already lasted six weeks. The Indian market has performed in line with many markets in Asia and elsewhere (including the United States), which too have seen price surges of 25 per cent and more. As the economy gets into the quarterly corporate results season, the question is whether this rally has still got legs, or whether it will now run out of steam.

Several factors have caused the price surge. Valuations were low, and all that the market needed for an uptick was some good news as well as an end to the fear that things might get worse on the economic front. As it happens, the message in the news of recent weeks has been that the worst may be over for the Indian economy, even if a recovery is not imminent; and that some sectors (like steel and cement, and some categories of automobiles) have seen an upturn in demand. The renewal of growth in bank credit in March was another positive indicator. Most forecasts for the economy in the new financial year have placed growth in the same ballpark range as the 5.3 per cent reported by the government for the October-December quarter, and this has suggested to investors that the bottom of the business cycle has been reached. In addition, the market has been buoyed by renewed investment flows from overseas, with the rally being triggered by two big US banks reporting that their fortunes had turned.

However, most observers continue to believe that this is a bear-market rally, and there is reason to give weight to their opinion. The signals in the debt market, including the spreads on corporate debt, suggest that the US economy still has some question marks hovering over it. In India, the volatility index for the stock market has been climbing in recent weeks, and this suggests that a price correction could be in the offing—though most people would be surprised if the correction went beyond 15 per cent. Also, the slackness in the money market is a worry point; banks are flush with funds and are busy dropping deposit rates, and at the same time parking Rs 100,000 crore and more with the Reserve Bank of India, using the reverse repo window to get 3.5 per cent interest. The softness in the credit market, the continuing sharp fall in exports (about 30 per cent in March) and the lack of industrial growth are all indicators that fail to support any thesis that argues in favour of an economic upturn, which is usually needed for the start of a bull market.

In the coming weeks, attention will be focused on the flow of corporate results and the outcome of the Lok Sabha elections. On the latter, the informal betting has been that a Congress-led coalition will return to power, with Manmohan Singh as the prime minister; any surprise on this score could send the market down, because there would then be renewed fear of political instability. It is also not certain how much of bad corporate news the market has discounted. If company performances turn out to be worse than expected, that too could kill the present rally. Such doubts could in fact provoke the profit booking that is a feature of bear-market rallies, and that too would lead to some price correction.