Sensex Making All Time Highs- Is the Optimism Justified?

Posted in Finance Articles, Total Reads: 1300 , Published on 24 October 2014
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In the year 2013, Federal Reserve announces to decrease buying of toxic assets from the market. This announcement impacted Indian financial markets to an extent. We use data of exchange rates, foreign reserves and equity prices between April 2013 and August 2013 to analyse the frequency of impact on India. It found significant impact on the Indian economy which allowed real exchange rate to appreciate and CAD to widen before QE rounds. Investors tried to balance their portfolio when they perceived that US economy is coming to stable state. Meanwhile the Sensex also tumbled as FII’s were flown out due to lower investor confidence and political instability.



In May 2013 Federal Reserve began the talk of possibility of tapering the Quantitative Easing program. Fed tapering is gradually decreasing purchase of toxic assets from the market. Since the subprime crisis Fed started infusing dollars into the market by buying toxic assets or Household mortgage security papers from the major financial institutions. With the economy showing sign of improvement, Fed lowered the buying rate to buy these assets. This process is called fed tapering. Several determinants are used to identify this impact like budget deficit, public debt, forex reserves and GDP growth rate, size and openness of countries economy and inflow and outflow.



After analysis it is found that determinants like budget deficit, public debt, forex reserve and GDP growth rate have very small relation or no relation with the Fed tapering impact. Investors tried to balance their portfolio so they were looking for the size of the financial market. Indian market being more liquid and large financial system with only current account convertibility and fixed rate regime leads to attract some big investors. In Indian market, equity can be sold without incurring losses. Hence it attracts investors to invest a lump sum amount.


Central bank of USA announcement of QE leads to several effects on domestic financial markets as well as international markets. This leads to manifold change in the balance sheet of Federal Reserve. Interest yield rate were almost close to zero. On the contrary, Fed announces fed tapering which leads to spill over effects on Indian market. FII net inflows started decreasing which resulted in the fall of stock market, more outflow, depreciation of local currency and reduction in forex reserve.


Sensex depends on the various macroeconomic factors but FII’s and investor sentiment matter a lot. The positive news of new NDA government under Narendra Modi’s leadership also led the Sensex to touch new heights before he became the Prime Minister and many stocks like Adani power, Gujarat gas, etc were predominantly reaching zenith. Only on the announcement of certain project being undertaken by such big companies, the market receives it with great optimism and the stock goes up instantly considering a much higher return from future cash flows. (NPV being positive and a good IRR)


From 16000 in 2012 to 25000 levels in 2014 (so called bullish markets) along with the rupee strengthening and stabilising against the US dollar is a good sign for investors but ultimately its not just about Sensex value reaching new heights; it is about the actual development in terms of infrastructure, manufacturing of products locally and living conditions that exists on the ground level. Metal, healthcare, power, capital goods, auto, FMCG, banking and consumer durable segments logged the biggest rise. Globally, Asian stocks ended higher after reports showing manufacturing expansion in the US pushed American stocks to records. European markets were also trading higher.


CAD is now dropping in just 1 year with a positive outlook on the economy and GDP being growing at a good rate. Some large market cap companies like Infosys, reliance, TCS and Wipro also affect Sensex to go up or down on their financial results declaration.


Infrastructure finance company IDFC Ltd. rose 6.34% after Morgan Stanley upgraded the stock to “overweight” from “underweight” and raised its target price to Rs175 from Rs115. This shows that the impact of credit rating agencies and investment banks should not be neglected. Some good stocks tend to lose their sheen if management is not taking right decisions according to the shareholders expectations or being caught in crony capitalism wherein the leadership of the company is neglecting minority stakeholders.


We have taken three main parameters to show the impact of fed tapering on Indian Market- Stock market data, exchange rate and forex reserves.

Forex Reserve:

Forex reserve for the period of April 2013 to August 2013 are as follows-

Sr. No.




Month & Year



Forex Reserve (in billion Dollars)

1

April 2013

296.3

2

May 2013

287.9

3

June 2013

284.6

4

July 2013

280.1

5

August 2013

275.5


Stock Market:

The average range of stock market for the period of April 2013 to August 2013 is as follows-

Sr. No.




Month & Year



Average Sensex range for a month

1

April 2013

19504

2

May 2013

19760

3

June 2013

19395

4

July 2013

19345

5

August 2013

18619


FIIs themselves may not be motivated to take money back since the U.S. Fed, along with the Bank of Japan and the European Central Bank, is committed to maintaining low interest rates. Unlike the June-August period, the announcement of tapering may not induce a hot money outflow — if at all, the amount would be small. As such, markets will not be seriously rattled.


After Fed tapering announcement, India was worst-hit, having come to depend on FII investment. The knee-jerk reaction of FIIs was to reduce exposure to emerging market economies in the expectation that liquidity would dry up and interest rates would harden.


Between June and August, FIIs pulled out 230 billion rupees ($3.7 billion) from the stock market, dragging the Sensex down 2000 points or by 10 percent. The rupee was also hit, losing 27 percent in three months and the RBI was forced to take emergency measures to stop and reverse its fall.


Policy actions have reduced the economy's external account deficits and reliance of short-term external flows, fiscal consolidation has continued, and inflation respite is palpable.


The domestic economy is influenced majorly by local factors as opposed to external. Hence, it is expected to remain largely unaffected by the ongoing tapering program of the Fed.


Regression Analysis:

Regression Analysis is done to show the impact of decrease in net inflow on Indian market by using three parameters- Sensex Data for the mentioned period of fed tapering, Exchange rate and forex reserve for the same period.

The regression equation obtained is –


Y = 23672.1-125.2X1+10.6X2


Where

Y- Sensex Range

X1- Exchange Rate for the mentioned period

X2- Forex Reserve


SUMMARY OUTPUT

Regression Statistics

Multiple R

0.956940168

R Square

0.915734485

Adjusted R Square

0.747203455

Standard Error

240.2135715

Observations

4


Since R square value is 0.9157, it shows a strong relation between Sensex, exchange rates and forex reserve. There is also significant correlation between exchange rate and forex reserve.


After analysis of all the facts, we can say that the impending QE taper is likely to hurt India in the short run, before the resilience of the Indian economy comes into play over the medium term through a natural adjustment of the trade imbalance with a more competitive rupee. The immediate impact would be on the rate sensitive bond market where foreign institutional investors (FIIs) had huge investments.


The findings after all the factual data of forex reserve, stock market and exchange rates show that Fed tapering which is expected to continue and consequent liquidity reduction may do little exacerbate the financial market and the real economy in India. This is received as a neutral impact of tapering on Indian market. Although there is decrease in net inflow of FIIs, the spill over effect is not so severe till now and the Sensex rally will continue for the days to come.


This article has been authored by Mufaddal Dahodwala from JBIMS


References:

http://www.fedtapering.com/

http://www.x-rates.com/average/?from=USD&to=INR&amount=1.00&year=2013

http://dbie.rbi.org.in/DBIE/dbie.rbi?site=home

http://www.investing.com/indices/sensex-historical-data

http://economictimes.indiatimes.com/articleshow/32541301.cms?utm_source=contentofinterest&utm_medium=text&utm_campaign=cppst

http://www.business-standard.com/article/opinion/the-qe-taper-effect-on-indian-equities-113082601102_1.html



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