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The rupee’s plunge over the past couple of sessions should be a reminder of how fragile the apparent recovery has been. Coupled to the rise in wholesale inflation numbers, it amounts to the first technical test of the rally we have seen over the past month.
The election results were released on May 16. The market had closed on May 15, at levels of roughly Nifty 7,125. Since May 16, the market has tested resistance at 7,700. It reacted back to the band of 7,475-7,500 as the Iraq crisis started. Support at those levels have held and the market rebounded on Tuesday to move back above 7,625.
India is in far better shape than last year when it comes to dealing with a potential external crisis. Forex reserves have risen. The rupee has found some degree of stability. The balance of payments situation is much more comfortable and the trade deficit is down, as is the current account deficit.
However, as India has to import most of its crude oil and about a third of its gas (and some coal as well), the market is bound to be nervous about trouble in the West Asia. This has already meant a little pressure on the rupee and also means there is a little more in the way of fear on inflation.
The market appears to have shrugged this off. However, if the technical trader wants a confirmation, he or she must wait for the index to cross 7,700, registering a sequence of higher highs. Also, given the nature of the crisis, there is a fair chance that there will be repeated bursts of adverse newsflow, depending on the fighting in Iraq. This could result in repeated bursts of volatility, especially in energy prices.
One obvious defensive hedge to such situations is the IT sector, with its negative correlation to the rupee’s strength and its non-correlation to domestic inflation. Another hedge is a long position in crude contracts – this is risky however, due to the high leverage and the likelihood that rates will swing both ways. A third possible hedge is a long dollar-rupee – again, high leverage and volatility makes this fairly risky.
The trader should also think of the traditional defensive sectors. Pharma has some problems and its very highly valued in terms of PE ratios. But it is an export-oriented sector and there is a chance that it will swing up.
The other traditional defensive sector is FMCG. FMCG is highly valued and it could get hit if domestic consumption continues to slow down. However, it does have some defensive strength in terms of protection against inflation. By and large, downgrades in terms of cheaper soaps and toothpastes occurs only in terms of desperation and so, FMCG companies can pass on some enhances costs. Also, by and large, FMCG companies tend to be low-debt and, therefore, not so badly affected by high interest rates.
The author is a technical and equity analyst
