The gloom and doom forecasts that were prevailing for markets a few months back are now turning into bullish forecasts. Sensex forecast from 15,000 and below levels is now 20,000 and above levels. The latter is more plausible than the former given that the Sensex is just 1000 points or 5% away from 20,000. The Sensex has risen from levels of 16,000 since May 2012 to current levels of 19,000, a return of 18.7% over the four month period. The reasons for the sudden turnaround in equity market sentiments are quantative easing by central banks including the Fed, ECB and Bank of Japan, turnaround by the Indian government in taking reformist policy decisions and expectations of rate cuts by the RBI in its forthcoming policy reviews.
The question to ask is whether the turnaround in equity market sentiments is warranted or not. The answer is yes, the turnaround in sentiments is warranted and markets will trend higher going forward. The three R’s will drive equity and bond markets higher. The first R is “Reforms” with the government ready to announce a second wave of reforms in the pension and insurance sector. The first wave of reforms was increase in FDI limits in retail and aviation and rationalization of fuel subsidies. The third wave of reforms will come in October 30th, with the government slated to announce fiscal consolidation measures.
The reforms by the government will help RBI take a call on rate cuts in its policy review on the 30th of October 2012. RBI has indicated that a government committed to reforms will help rein in long term inflation expectations and with an economy that is expected to weaken from levels of 6.5% growth seen in 2011-2 to levels of 5.5% for 2012-13, the probability of a repo rate cut is extremely high. Prospects of rate cuts coupled with fiscal consolidation measures are positive for both equities and bond yields. Ten year benchmark government bond yields at 8.15% levels will trend down going forward.
The Rupee is a beneficiary of positive equity and bond market sentiments. The Rupee had touched all time lows of over Rs 57 to the US Dollar in June 2012 but has since then strengthened by 8.5% on the back of improved market sentiments. The Rupee has seen its worst for some time and is expected to trend higher as capital flows into equity and bond markets increase. A strengthening Rupee leads to more flows as FII’s rush to capture a rise in the value of the Rupee.
What should you do with your money now?
You must be understandably hesitant to invest in equity markets at current levels of the Sensex at 19,000. Nothing has changed on the ground except sentiments. Outlook for the economy is still weak, corporate profitability is not going to improve in a hurry and the government may not have the political backing to push reforms. However despite market being at higher levels and economy not looking great, the conditions for equity markets going up as pointed out above are positive. You can invest in equities either in the index itself, as it is less volatile than stocks or in stocks where you find value or in well managed diversified equity schemes of mutual funds.
You will be more confident on bonds given that the benchmark ten year bond, the 8.15% 2022 bond, at 8.15% levels has not moved much since the time it was issued in June 2012. The outlook for bond yields going down is positive given that markets will take rate cuts positively and fiscal consolidation measures will be welcomed by bond traders as it keeps government borrowing as per budget schedule. Long term income and gilt offers will help you capture the returns from falling bond yields.