Hop on, its a joyride

The US Federal Reserve’s move to cut interest rates by 50 basis points is its first in the past four years. It is a reaction to the disruptions triggered by the US sub-prime crisis. This will set the tone for the Indian market to break out and move to the next orbit.

Markets across the globe cheered this move, and India was no exception. The Sensex closed above the 16000 mark for the first time on Wednesday. The question uppermost on investors’ mind is: will the Sensex sustain these levels? We remain optimistic about India because of fundamental or macro-economic reasons, as well as technical or liquidity reasons.

Macro-economically speaking, India has never had it so good. We have entered the 9%-plus real GDP growth band, and it looks like these growth rates will be sustained. Apart from agriculture, both manufacturing and services are firing on all cylinders. This growth will have a trickle-down effect on the rest of the economy.

Travel anywhere in India, and you will see the impact of retail spending and the telecom revolution. However, infrastructure remains a big bottleneck. Certain states have woefully inadequate infrastructure, but it looks like slowly, the powers to be have realised the need to invest in this sector. We’re optimistic that in the medium term, this issue will be resolved. Commodity prices are also stabilising after being volatile in the past. This will benefit all old economy stocks.

India was relatively unaffected by the subprime mess. The only visible impact was in FII selling, primarily due to hedge fund redemptions. The Fed rate cut signals that the phase of rising interest rates is finally ending and from now onwards, interest rates will stabilise, if not fall.

The Reserve Bank of India (RBI) is expected to follow suit. Inflation rate has fallen to 3.5%, the lowest in almost a year-and-a-half. Hence, chances of RBI reversing its stance on interest rates are quite high. A fall in interest rates will revitalise all interest rate-sensitive sectors like housing, banking and automobiles.

With the Fed rate cut, emerging markets will re-emerge as the investment destination of choice. Decoupling notwithstanding, a shift of funds from dollar to non-dollar assets is expected, with a growing interest in high-growth destinations like India and China. We expect the domestic capital market to see a surge in foreign funds, which spells good news for both stock prices and indices.

Earlier, foreign money was the first to shy away from emerging markets during global upheavals. FIIs’ intense selling pressure, coupled with drying up of liquidity, is a double whammy. But the case is different this time in India due to deep domestic liquidity.

The direction of the market is no longer determined solely by FII inflows — as was the case in the past — but also by domestic institutions like mutual funds and life insurance companies, which have ample cash to invest in the market and do bottom-fishing.

These domestic institutions are one of the prime reasons why the market remained stable, despite FIIs being net sellers to the tune of $2 billion during July-August ’07. Hence, the domestic stock market is no longer as dependent on ‘foreign funds’ as it used to be, since Indian institutions themselves are now of a size to be reckoned with.

A surging economy, coupled with healthy corporate numbers, will set the tone for the market to reach new highs. The only spoilsport can be political instability. Domestic consumption, capex cycle and the Indian outsourcing story will be the key investment themes.

Technically speaking, the market has broken free from the critical resistance levels of 15973. So, too many eyebrows may not be raised if the Sensex breaches the 18000 mark on ‘Mahurat’ trading day. Be ready to enjoy fireworks this Diwali as the best is yet to come. Come and join the joyride!