Rally after US Fed rate hike stumps experts

Usually, a rate hike by US Federal Reserve or Fed isn’t viewed as positive, particularly for emerging markets (EMs), because higher interest rates increase the price of funds (liquidity) that typically chase riskier assets like EM equities, for higher returns. If past performance is any indicator, the traders were bracing up for some correction or consolidation in Thursday’s trading session. But, what happened instead was totally contrary to past performances and even logic. The S&P BSE Sensex gained 187 points and CNX Nifty closed at its all-time high of 9,153 points. Experts unanimously say that Thursday’s trading session is clearly a case of sentiments overtaking logic or underlying market fundamentals. And, from current levels, downside is much higher than upside.

“BJP (Bharatiya Janata Party) winning election in Uttar Pradesh has changed the sentiments even for foreign institutional investors. So any news tends to be interpreted by sentiments and that’s what played out on Thursday,” Lalit Nambiar, senior vice-president and fund manager, equity, UTI Mutual Fund, says. Another fund manager points out that some segment of institutional investors’ interpreted US Fed rate hike and the commentary by its chief as signs of improvement in growth in the US. Janet Yellen (the US Fed chief) has targeted for two rate hikes this year and three next year. “Normally, this would be interpreted as a cap on global liquidity. But this time, equities the world over view Fed’s decision as green shoots of growth. When the leadership in the US is taking aggressive stance on protectionism, it is unlikely that India would gain from US growing this time,” he warns. Experts suggest that measures such as lowering tax rates for companies, which will increase their presence in the US, could be detrimental to India. “Indian equities are completely ignoring the global headwinds,” Gautam Chhaochharia, head of India research, UBS says.

What also worries experts is the lack of depth in market fundamentals in the current rally. “Only two bull market rallies out of six that Indian market has witnessed so far (1993-97 and 2003-07) have been supported by growth in earnings. Otherwise, it is largely just a price-earnings expansion. This has been the nature of equities and I don’t see the current rally any different from what was in the past,” Nambiar adds. “The market is behaving blind to another round of earnings downgrade,” CEO of domestic brokerage flags off. “Without visibility on earnings, it might be tough to justify valuations,” says Pramod Gubbi, head of equities, Ambit Capital. “Not much of earnings' downgrade likely due to adoption of goods and services tax in FY18 getting priced in. If the commentary after March quarter's earnings isn’t strong, I expect a break in the rally,” Gubbi adds. Chhaochharia is factoring in for eight per cent cut in earnings estimate for FY18. 

Nambiar, who largely handles a portfolio of mid-cap stocks, says he is now concentrating on stocks which could be relatively immune to global headwinds and could start delivering earnings once capacity-expansion cycle kicks in. “But, are we paying the right price for the stocks is the question to ask,” he adds. Experts believe that while it may not be a challenge to raise incremental domestic fund flows, stock selection may become very tricky. 

“There are fewer quality names left to consider compared to a year ago, and my guess is if the rally continues to be sentiment-driven, we will run out of options soon,” he cautions. There are other risks to earnings. Dhananjay Sinha, equity strategist, Emkay Global Financial, states that with higher Fed rate, Reserve Bank of India (RBI) too may not reduce its rates. Experts feel that this could worsen loan growth. “Implications of this could be far worse as it can further dampen the earnings projections,” Sinha states.

For now, experts advise investors to latch on to their savings and be very selective with their stock picks as at “frothy” valuations (Sensex at 22.9 times its companies’ FY17 estimated net profits), downside risk is higher than upside gains. Already, FY18 earnings estimate has been lowered by nearly 12 per cent since last March, and experts say there is scope for it to be lowered further.