Nifty above 8,500: Newton's law suggests bull market will continue in 2015

With the NSE Nifty briefly crossing 8,500 and the BSE Sensex targeting 28,500 in morning trades today (24 November), it is clear that the basic trajectory of the markets is upwards. There is no reason to believe that this trend will be reversed without serious challenges to market assumptions.

This much is certain from Newton’s first law of motion, which says that an object at rest will remain stationary and an object in motion will continue moving in the same direction and speed unless stopped or slowed by another force. Right now, the forces acting in favour of the Sensex and Nifty rising are stronger than those acting against it. Hence the trajectory remains northwards.

The forces pushing the indices to new highs are essentially global liquidity, driven primarily by foreign institutional investors (FIIs), political stability at the centre, steady improvements in the domestic business climate, the prospect of reforms, improving data on wholesale and retail inflation, and the Reserve Bank’s high credibility, both as an inflation-fighter and for its adroit moves on the management of India’s forex reserves and the value of the rupee. To this we can add prospects of improved corporate earnings next year, and the possibility of a turn in the investment cycle, too.

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As against this, the factors which could play spoilsport are primarily two: a world heading back to recession (or even deflation), and the inability of the Modi government to push reform bills as the opposition is uniting to prevent the passage of crucial legislation in the Rajya Sabha.

Let’s take each one of them and assess the possibility of a reversal.

**FII money:** Mint newspaper says today that FII inflows into equity and debt in 2014 will top $40 billion - the highest ever. Of this, the greater proportion (60 percent) has gone into debt. Will these flows suddenly cease or reduce? Unlikely, for the betting is that interest rates will have to start falling sooner or later. Once they do, FIIs could shift money from debt to equity, but this process will not happen all of a sudden. Also, if rates fall, that is a reason to invest in equity. With the world facing the problem of recession and weak inflation, most central banks will not stop printing money in a hurry. On balance, thus, FIIs are unlikely to suddenly start taking their money out, especially when other emerging markets look less enticing.

Political stability, reforms and business climate: These factors are related. As long as Modi and the BJP keep accumulating political capital in various state elections, confidence in reforms and governance will keep improving. It is obvious that the big shift in investor and corporate mood after mid-2013 came with the prospect of a change in government in May 2014. While no big bang reforms have been announced by the Modi government, this has been cushioned by a benign global environment which has enabled the deregulation of diesel and (possibly) LPG. Subsidies are coming down, and fiscal space is being created for government spending to resume next year so that the investment cycle can revive.

The political choice before Modi and his finance minister is: incremental reform or big bang. If it is the former, the market will correct after the February budget before resuming its secular Newtonian uptrend. If it is the latter, the market will head for 35,000-40,000 on the Sensex by 2015-end.

Inflation trajectory: Both wholesale and retail inflation are trending down, the former more than the latter, because of benign global commodity prices and moderated food procurement price increases, among other things. In a global scenario where China has cut rates unexpectedly due fear of falling growth, and where both Europe and Japan are planning a flood of liquidity to shore up growth and avoid deflation, clearly the macro problem outside India is not inflation, but deflation. This means commodity prices may stay benign - and this is better for India than soaring oil prices since we are huge net importers of commodities. It is unlikely that India will suddenly catch high inflation when the global trend is downwards.

The RBI’s stellar act: The central bank under Raghuram Rajan has been a pillar of strength for the Indian economy because he has not been stampeded into cutting rates prematurely. Nor has he allowed the rupee to appreciate wantonly. Given the volume of FII flows, the rupee should have appreciated to 57-59 to the US dollar, but it is at around 61.75 (as in mid-morning trades 24 November). Rajan’s RBI has prevented a rupee spike by buying dollars - and the forex reserves (over $315 billion as of 14 November) reflect this. Rajan’s policy is driven by two objectives: preventing an exchange rate shock by keeping the rupee depreciating steadily just in case the US starts raising interest rates and capital flows temporarily reverse (the rupee’s normal depreciation rate is about 5-7 percent per annum). The second objective is to keep returns on debt positive with relatively high rates. This ensures that FII investments in debt remain attractive even while promising lower inflation. Rajan has ensured that there will be no sudden exit of FII money in the foreseeable future - which means up to mid-2015 at least - no matter what the US Fed does.

The downside risks to the market can be summed up in one word: politics. If Modi is seen to be losing political traction by unexpected reverses in some state assembly elections, and/or if the opposition manages to stall major reforms in the Rajya Sabha, the markets will obvious start correcting to adjust for slower reforms. But this will be obvious only around the time of the budget in February, and by then we will know what happens in J&K, Jharkhand and, most importantly, in Delhi. Equally important, how Modi manages the Shiv Sena in Maharashtra will be crucial. If laws have to be passed by holding a joint session of parliament, the Sena’s 18 MPs will be crucial.

The balance of risks is thus still in favour of a market rising at least till February, followed by a correction, and a revival again in the second half of 2015 when rates start falling.

An Economic Times investment roundtable featuring Nilesh Shah of Axis Capital, ace stockbroker Ramesh Damani, Prashant Jain of HDFC Mutual fund, Sankaran Naren of ICICI Prudential Mutual Fund, Shankar Sharma of First Global and Pankaj Vaish of Citibank (head of south Asia markets), buttressed this optimism today.

Jain pointed out that “in the last three or so bull markets, the markets have never peaked below PEs (price to earnings ratio) of 25 times… this time we are still at 16-plus PEs right now.” This means there is adequate headroom for the indices to rise. Naren sees an additional positive: “there is very little competition from other emerging markets” for global funds, “unlike in the 2002-07 cycle.”

But it isn’t also only FII money driving stocks. Nilesh Shah told the roundtable that between SIPs (systematic investment plans) and bulk money flowing into mutual funds, over Rs 30,000 crore is available for investment (in both equity and debt). Pankaj Vaish said next year should see the indices rising 20 percent.

Net-net, the markets continue to be in a sweet spot and it will take a lot of political failure to neutralise that. Newton’s law is still in favour of a bull market in 2015.