Mid, smallcap indices hit record high. Why are markets ignoring oil prices?

The markets seem to be ignoring the rise in crude oil prices, which have shot up over $90 a barrel (bbl) this week – up nearly 5 per cent in the last one month and around 9 per cent in the last fortnight alone – amid supply cuts by Saudi Arabia and Russia.

While the S&P BSE Sensex mostly remained flat in the last one month, the S&P BSE Midcap and the S&P BSE Smallcap indices have surged 6.5 per cent and around 8 per cent, respectively, during this period to hit their respective all-time high levels of 32,286.11 and 38,146.93 on Thursday.

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A key reason for the Indian markets to ignore the oil price rise, according to U R Bhat, co-founder and director, Alphaniti Fintech, is the fact that India has been buying relatively cheaper crude from Russia and other geographies, which could keep inflation-related woes at bay.

"India has been substituting expensive crude oil with cheaper imports. This has helped keep inflation-related concerns triggered by rising oil prices at bay. That said, foreign institutional investors (FIIs) have started selling off-late, while the domestic institutions and retail investors are buying. For the markets to sustain and move up from here on, FII support is needed. Any negative news can see the index fall around 5 – 10 per cent from the current levels," he said.

Meanwhile, oil imports from Russia surged nearly three-fold in July, according to reports, at $12.26 billion, 170.66 per cent higher year-on-year (YoY).

A rise in oil prices, typically, triggers a fear of a possible rise in inflation, especially for India, which imports nearly 80 per cent of its annual crude oil requirement. Led by vegetables, food inflation in India soared to an over three-year high of 11.5 per cent in July, pushing headline inflation to 7.44 per cent.

On a boil

Going ahead, analysts see Brent crude oil closing in on the $100 a barrel mark over the next few months amid supply constraints, though slower-than-expected pace of growth in the Chinese economy, they feel, could cap the runaway rally.

The recent supply cuts by Russia and Saudi Arabia could see oil prices close to triple digits, said G Chokkalingam, founder and head of research at Equinomics Research. Inflation fears, he believes, would then be firmly back on the table and the central banks may have to alter their policies.

"Unless oil prices fall and crop prices moderate significantly, tight monetary policy (high interest rates) executed over the last 18 months in most major economies could ultimately lead to significant deflationary conditions in the global economy. This, in turn, could bring down global equities. Back home, FIIs are selling in the secondary stock markets, and are unlikely to come back in a hurry. We are quite nervous on the small and mid-cap segment in the short-term," he said.

Testing times

The next few months, according to analysts at Prabhudas Lilladher, will be a testing period for the Indian economy and markets as the nation embarks on several states, and then the general elections in 2024.

Expected interest rate hike in US and its impact on INR/USD with impending political and inflation risk, they believe, can impact flows going ahead.

"We expect markets to start factoring in political risks as election related activity picks up. The economy is getting a big push from government-induced capex, even as rural India is showing faint signs of recovery and urban discretionary demand remains tepid. High inflation can be a political hot potato in an election year, forcing the government to slow capex," wrote Amnish Aggarwal, head of research, Prabhudas Lilladher in a recent note.