The rise in the equity markets in July was beyond expectations with the Nifty50 index surging nearly 9 percent. This comes on the back of a 5 percent decline in Indian indices in June. In July, the inflation concerns eased and expectations of fewer rate hikes from the US Federal Reserve (Fed) helped cool off bond yields and improve portfolio flows, which in turn helped the market turn positive.
For August 2022, brokerage house HDFC Securities feel that the Nifty could broadly track the trends in the global markets and remain in the 17,700-16,100 band. HDFC noted that markets typically go from one extreme to another. The fall in the markets in mid-June was also more than required while some people have started to feel that the recent steep rise in indices is the other extreme, it said.
"A few things came together in July. Commodity prices (including crude oil) prices corrected, and the US dollar retreated after remaining strong for 6 weeks from the end of May 2022, US Fed Chair came out with a statement that was interpreted as giving a signal that the Fed will now go slow on raising rates, Inflation seemed to have topped out while economic activities did not show any signs of an impending recession," HDFC Securities explained in a recent report.
Going ahead, the brokerage pointed out that the investors remain doubtful as to whether markets have bottomed out as inflation remains high, Central Banks have not finished raising rates and corporate earnings are yet to show any signs of a slowdown. Bond markets are also clearly flashing a classic recession warning signal. The two-year US treasury note is trading at a higher yield than that of the 10-year benchmark note, it stated.
Despite all the volatility in the economic data, the stock market is not scaring off many retail investors, highlighted the brokerage. People appear to be keeping the lessons of the pandemic-induced stock market drop and subsequent resurgence in 2020 at the front of their minds, HDFC stated.
However, it pointed out that traditional market participants will get back into the markets when we are going to see signs of a bottoming in profits or you’re seeing signs that liquidity is going to get pumped back into the system.
"Some optimists are excited about the better than feared earnings and signs of peaking rates and feel that US growth should remain well supported by consumer demand, business investment, and government spending. The equity market is taking its cue from the bond market and is starting to think the Fed has done enough to regain its credibility and will ultimately win its war with inflation. This also suggests they may be able to pivot/pause on rate hikes later this year (or sooner)," noted the brokerage.
But history suggests inflation needs to peak before the Fed will stop tightening. Not only will the Fed tightening cycle persist longer than bulls appear to anticipate, but expectations for corporate-profit growth will also likely remain too high to support even diminished valuations, HDFC said.
The most pressing issues are the effect the economic slowdown will have on corporate earnings and the risk of the Federal Reserve over-tightening, it added.
Going ahead, investors expect more cuts to earnings estimates as concerns around growth spread, especially as companies highlight signs of consumers trading down to lower-end products and services, weakening demand and too much inventory, noted HDFC.
"While the stock markets globally don’t seem to be bothered at the moment about the economic growth or impact on corporate earnings, the two new concerns (China issues and high gas prices) could play out and create another panicky selloff. The risk to this bearish scenario is an early resolution of the Russia-Ukraine conflict," predicted the brokerage.
