Resistance to rally building up

Mumbai:  There are signs of resistance building up to a stock rally in India after some disappointing quarterly earnings and a hawkish stance by the central bank, which last week raised interest rates for the fourth time in five months to hammer down high inflation.

While bountiful rains have cooled runaway prices of food items that had been the primary reason for double-digit inflation over the past several months, manufactured goods and fuel have become the main drivers of price rise as strong economic growth strains industrial capacities.

Economists believe the lack of investment in expansion and new projects following a global slowdown after the Lehman collapse almost two years ago is now putting pressure on supplies as demand from consumers picks up. This has the potential to create asset bubbles and a possible hard landing that could be painful.

The Reserve Bank of India (RBI) is worried and it has announced a more frequent review of policy to tackle the emerging scenario. Last week a senior central bank official told reporters: "Monetary tightening has to be more aggressive." The comment came after the RBI had raised rates for the second time in July, and was clearly intended to warn the markets about more rate rises in the offing.

The RBI has scheduled a policy meet in September ahead of the usual one in October, and has said it would hold mid-quarter reviews from now on. "This is not heartening news for investors," said equity trader Ram Pradhan. "The aim is clear: the RBI wants to cool demand and rate hikes will pinch the pockets of consumers. It will finally slow down earnings growth and share prices would need to reflect this."

The top-30 Sensex eked out a 0.9 per cent rise in July, a poor performance compared with its emerging market peers in Russia, Brazil and China that rallied around 10 per cent.

"There are question marks about the valuation of Indian stocks," said Pradhan. "Some of the downgrades seen last week indicate people are toning down the outlook."

Among the stocks that took a hit last week was Maruti Suzuki, the country's biggest carmaker, after it posted an unexpected 20 per cent fall in June quarter net profit and a host of brokerages including Citigroup slashed their ratings. The share at one stage fell 12 per cent, which was the most since it began trading on the exchange in 2003.

Hero Honda Motors, the leading maker of motorcycles, and state-run explorer Oil and Natural Gas Corp also disappointed investors with their earnings and were promptly dumped. The results from cement and steel companies were also poor.

Brokerages also cut their ratings on energy giant Reliance Industries after it became evident that it was running behind schedule by at least two years to reach full capacity of gas output from its huge field off the east coast.

Another warning came from Michael Hartnett, Bank of America-Merrill Lynch Global Research's chief global equity strategist, who said emerging market stocks were poised for a fall in August based on a "trading rule" study.

Foreshadow

Citing data from EPFR Global of $3.2 billion (Dh11.76 billion) moved by investors into emerging-market funds in the past week, taking four-week inflows to about 1.5 per cent of their assets under management, he said this was a phenomenon that usually foreshadowed market declines.

The last sell signal on April 28 was followed by a 9.2 per cent decline in the MSCI Emerging Markets Index the following month. Similar signals in April 2008, July 2007, September 2007 and April 2006 also predicted market drops within about four weeks, Hartnett wrote in a report.

"Today, compared to April, consensus is less bullish on the global economy and less positioned in global equity markets," he said. "But the trading rule strongly predicts relative underperformance by emerging markets in August. We continue to predict medium-term outperformance by emerging-market equities."

 The writer is a journalist based in India.