Be watchful this week

Volatility is likely to be the highlight of the market in the week ahead. Cautious investors may utilise upsides to trim exposure to a market that has risen briskly and without any major pause till Friday. With foreign funds expected to continue pouring money into Indian equities unless there are indications that there would be no further rate cuts by the US Fed on October 30, the bias is broadly positive.

But, as of now, valuations of most shares are stretched and corporate earnings are showing signs of a slowdown. Optimists can take heart from robust industrial production figures and the latest comments by top Congress leaders that mid-term polls are highly unlikely. But experts argue that current market factors in most positives and leaves little room for disappointments.

There is a perception that catalysts for a sharp correction could be external such as a sudden selloff in the US markets. The absence of a rate cut by the US Fed, as expected by the market, could trigger a sharp correction in most emerging markets including India.

The Sensex has risen 20% since the US Fed rate cut on September 18, sparking sharp foreign inflows into many frontline shares, with several investors pulling out money from the US to invest in higher-yielding assets of emerging markets.

CLSA Asia-Pacific Markets’ analysts, in a recent note, says, “The extent of the rally and the lack of breadth suggest that in the event of any reversal in global risk appetite, deterioration in global credit markets or an escalation in political tensions domestically, the correction could be fairly sharp.”

As per CLSA’s findings, 68% of the Sensex’s gains so far this year is attributable to just five shares, constituting only about 36% of the index’s free-float market capitalisation. These five shares include Reliance Industries, Bhel, L&T, Bharti and HDFC.

Concerns about further tightening of domestic liquidity by the RBI is a cause of concern for investors. With the industrial production growth back on track this August after a sharp decline in July, analysts are almost certain that RBI would mop up excess money supply in the system through a hike in cash reserve ratio.

Investors in interest-rate sensitive sectors such as banks, real-estate and auto, fear that banks may not cut lending rates further in case of more absorption of money supply from the system.

“An increase in CRR or expectation of an increase in CRR is likely to cause some weakness in financial stocks. We would use this weakness to buy into our preferred stocks–HDFC, IDFC and the State-owned banks,” Morgan Stanley analysts said in a recent note to clients.