Markets to remain on edge amid global headwinds

Indian equities are expected to trade with a negative bias and remain volatile in the next few months given the sticky inflation in the US, anticipation of more interest rate hikes by the Federal Reserve, geopolitical tensions and the collapse of a bank in the US.

“Volatility will continue as the interest rates in the US are expected to peak beyond 5.5%. The yields are inching up in the US and investors will be happy to get a risk-free return of 4-6% than invest in a country where the currency is depreciating 4-6% every year. The Russia-Ukraine war remains a cause for concern as well,” said UR Bhat, director, Alphaniti Fintech.

Indian equity markets posted negative returns for the third month in a row in February. In the past three months, the Nifty 50 is down 5.8% while the Nifty Midcap 100 and Nifty Smallcap 100 are down 5.1% and 6.4%, respectively. The benchmark Nifty is still below the 18,000 levels it hit in October 2021. Mid and smallcaps tend to underperform in a high-interest rate environment, which is likely to persist for some more time.

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The US treasury yields breached the 4% levels a few days ago, but have retreated since then over fears of contagion in the financial sector following the collapse of Silicon Valley Bank and robust February employment data.

“Monetary tightening expectations in the US have ratcheted up again following Jerome Powell’s Congressional testimony on Tuesday, with the terminal rate now put at 5.64%,” said Christopher Wood, global head of equity strategy at Jefferies.

The usual lags in the impact of monetary policy will be greater than in the past because the credit boom in this cycle has been in the private lending market, the dynamics of which are much less understood by central bankers, said Wood. “This will create a bigger risk of an even more pronounced bull trap market rally than normal as investors become convinced that the downturn can be avoided,” he said.

The collapse of SVB last week may prevent the Fed from opting for an aggressive 50 bps rate hike this month and settle for 25 bps instead. Market pundits are still weighing the consequences of the bank’s collapse given its presence in other geographies such as China, India and Israel. Fears on the bank‘s failure potentially wiping out startups around the world without government intervention are gaining ground.

“As rates go higher, there are likely to be unintended consequences. The recent bank collapse in the US may lead people to wonder if there are other problems lurking out there which can impact the global financial markets,” said Andrew Holland, CEO, Avendus Capital Public Markets Alternate Strategies.

“It is unlikely to be a Lehman moment but global leaders need to work together to contain the contagion,” added Bhat.

India’s valuation remains stretched relative to its emerging market peers, and rotation of FPI flows to other markets may lead to some consolidation in the near term, said experts. “We are still expensive and earnings upgrades are less likely, especially in the first half. Unless the Fed went on hold, there is no catalyst for the markets at the moment,” said Holland.

FPIs have net sold shares worth $2.5 billion in the year to date. Flows are likely to get a boost in the second half as earnings growth starts to pick up and funds specialising in emerging markets allocate more to India, said experts.

The Nifty is trading at about 18x FY24E EPS. There is room for modest upside if corporate earnings do not see material downgrades ahead, according to experts. Corporate earnings for the third quarter were below expectations led by weak demand environment and macro headwinds.

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“The Street expectations for earnings growth in the March quarter are not too high. Banks, which account for a large chunk of the benchmark, are expected to do well, along with metals and oil & gas,” said Bhat.

The short-term trend of the Nifty continues to be weak. “Having formed an unfilled downside gap and a formation of positive candle pattern of Friday indicates possibility of minor upside bounce for the market, which is likely to be a sell-on-rise opportunity for next week. Immediate resistance is around 17,600 levels and the next lower supports to be watched at 17,250,” said Nagaraj Shetti, technical research analyst, HDFC Securities.