The markets, subsequent to a smart move which has seen benchmark indices move to new highs and Mid Caps give much higher returns are now faced with a dilemma of greater bullishness in the longer term versus headwinds in the short run. Moreover the May factor is also playing in the minds of most investors as this month is typified with huge volatility. The market commentary of “Experts” has also turned extremely bullish over the last two weeks.
Some of the near term headwinds are
Increasing likelihood of a weak monsoon- Although one weak monsoon does not change the long term story of India to any great extent, things this time are slightly different as gross mismanagement by the outgoing UPA Government has kept food inflation high despite good monsoons and record food grain, milk etc production combined with significant increases in MSPs over the last 5 years. At a time of high food inflation a weak monsoon will encourage hoarding and increase the expectations of lower production. This phenomenon by itself encourages the middleman network to try to push up prices. On top of this we have had some crop damages due to unseasonal rains over the last couple of months. Overall the probability of food product inflation remaining elevated has increased and as such given the focus of RBI on CPI the probability of lower interest rates gets pushed back further into the future.
Geopolitical Tensions & Crude Prices- Geopolitical tensions related to Ukraine as well as civil unrest in Sudan, lower oil production in Libya etc have kept crude oil prices elevated. Given weak demand, if production had panned out the way it should have we should have had much lower crude oil prices than we see today. Crude prices are negative for India from the perspective of Fiscal Deficit due to increased subsidies, CAD due to higher imports as well as higher inflation. In contrast we do have a balancing impact in the form of lower prices for most other commodities like Coal, Steel, Copper, Rubber etc. Increased geopolitical tensions at a time when most global markets are trading near their all time highs create a situation where we could get a sharp selloff in the near term.
Growing consensus bullishness- Consensus is becoming extremely bullish thus creating a contrarian sell signal in the near term. Most “Experts” who were predicting the markets to be near 5500 or at the maximum 6000 by the end of 2014 are now predicting 7500 for the Nifty. Though this does not change the long term picture in any way it does create probability of some correction in the short run.
On the other hand these factors are countered by the probability of greater bullishness over the longer term. The probability of a strong mandate to NDA is increasing by the day and this will help create a situation of stronger long term growth for the Indian economy. The global economic growth also seems to be picking up with most economic data from the USA and Europe showing increasing strength and the results in general beating expectations. Concerns relating to China also seem to be receding, although they still remain.
In conclusion I would think that the probability of a pre result correction has increased. If this fructifies the selloff in some of the high flying mid cap stocks could actually be quite severe. This could create an opportunity for those on the sidelines to come into the markets to play the POST NAMO RALLY.