From the Ring. Multiple challenges to galloping markets

Stock markets worldwide have been on an incredible uptrend for the last several months. We have seen some intermittent corrections, but those have been shallow and of very short durations.

Although I am quite bullish on the markets over the long term, the near-term picture does not look encouraging. The risks to the markets are predominantly global and somewhat local. Some risks that I see playing out are listed below.

The US dollar continued on a weakening cycle right through the quantitative easing cycles of the US Federal Reserve with intermittent rallies.

However, an improving US economy — at a time when the European economy faces a deflationary cycle, combined with faltering growth in Japan and China — has set the scene for a dollar rally.

The rally is also expected to be aided by continued stimulus from the ECB and Japan. The impact of a dollar rally will be two-fold. Firstly, it will cut into the earnings growth of US corporates and put pressure on US stock markets.

The second and more important impact on emerging markets is that a dollar rally can create a short-term squeeze of liquidity globally, specifically from emerging markets. The US Dollar Index has also completed a very bullish technical pattern and could see a sharp up move over the next two-three months.

In the first round of corrections in developed markets, the emerging markets held up quite well, driven by liquidity flows.

An imminent sharper correction in the western stock markets will take all other markets down along with them. However, the same might not be true in the second corrective leg. The markets could get very volatile with a downward bias as we approach the US Fed meeting on September 16.

The minutes of the last meeting indicated a growing difference of opinion on the future course of monetary policy. This could grow further as economic indicators coming out of the US are indicating sustained recovery.

The Gaza conflict continues to simmer while there is a growing mistrust between Russia and the NATO. The Ukrainian situation could get uglier before it is resolved.

The growth of the ISIS and an imminent Western involvement could also create near-term uncertainties. Markets in their bullish undertone have chosen to ignore most of these factors.

Runaway food inflation in India is likely to keep the RBI on hold for a longer period of time.

The positive base effect for consumer price index (CPI) inflation will start wearing off from September/October and the Government will have to get a handle on things by then.

The inability of the Government to push through certain legislation in the latest session of Parliament; such as changes to the Land Acquisition Bill, is a negative.

Poor agricultural growth due to a volatile monsoon is likely to affect near-term growth, as planted area has come down significantly compared to last year. This could impact rural demand, which has held up quite well till now.

The recent judicial pronouncement on the ‘coal-gate’ scandal could impact both growth and sentiments in the near term. India is already importing more than $10 billion of coal every year.

This could increase manifold if the issue is not sorted out rapidly. Iron ore mining is still stalled two-three years after a scam broke out in that sector.

The Syndicate Bank bribery scandal and growing concerns about the lending practices of PSU banks have put them on the back foot in the near term. And lastly, growing bullishness — with most brokerages coming out with competitively higher Nifty and Sensex targets — is another warning signal. Recently, one brokerage came out with a 30,000 plus Sensex target.

Although most of these factors will be short term and are unlikely to change the long-term trend of the market, it is only prudent to be cautious at this stage.

A correction could be to the tune of 6-10 per cent. Post correction we will get more constructive ideas to invest into. Till than, be cautious.

My suggestion to all traders is to take moderate positions so as to not get whiplashed in short-term market movements.

My base case assumption for the markets in the short run is a correction to the 7,100-7,300 range; this was where the Nifty was on the date of the Lok Sabha result announcement. That level should not be breached unless we have a full-fledged global crisis. That should set the trend for the next up move.

The writer is the founder of asksandipsabharwal.com