Where are the bulls and why is the market falling?

Between 01-Feb and 15-Feb, the Nifty rallied 1700 points. What has suddenly changed since then?

Feb 22, 2021 04:02 IST India Infoline News Service

The Union Budget announcement on 01-Feb was a sort of turning point for the stock markets. The Nifty and Sensex, which had been tentative ahead of the budget, shed all inhibitions. There were reasons aplenty. The government did not mince words on the fiscal deficit and set an aggressive 9.5% for FY21 and 6.8% for FY22.

There was a plethora of favourable announcements like a rapid rollout of the disinvestment process, a big focus on privatization of PSUs, opening up FDI in almost all sectors and a robust Atma Nirbhar plan for a renewed Indian manufacturing sector. Between 01-Feb and 15-Feb, the Nifty rallied 1700 points. What has suddenly changed since then?

Data Source: NSE

Where are the stock market bulls?

In a way, the market is rightfully confused. The budget euphoria is still intact. The government has been moving on a war footing even as the domestic economy is showing signs of a recovery. The third quarter numbers have been actually encouraging in terms of top line and bottom line. Above all, foreign investors are still active in the Indian markets and infused Rs25,000cr in the first 3 weeks of February.

In spite of these positives, the bulls appear to have vanished and the Nifty has been in correction mode for 6 out of the last 7 trading sessions. The rate sensitives like banks, financials and autos that spurred the rally have been dragging the markets down. What exactly explains this sharp correction? There are actually 4 strong reasons why the Nifty has fallen so sharply; with the fourth reason being the strongest.

1. COVID cases have risen in parts of India

At a time when the bugles were out and India was celebrating the success of the vaccine drive, COVID appears to have reared its head all over again. The impact has been most prominent in the populous and industrialized state of Maharashtra. Already parts of the state have gone into a semi-lockdown and the markets are worried that if the lockdowns recur then it would be the story of 2020 all over again. It may not be that bad, but nobody wants to take chances. After the recurrence in the US, UK and Europe, Indian traders are just being extra careful about the likely impact.

2. Oil is getting more expensive by the day

Whether the Arctic burst in Texas was the problem or the trigger is not clear. What is clear is that 4 million bpd of crude are stranded and it has left a deep impact on global oil prices. Brent Crude may have retreated from $65/bbl but nobody believes the spike is over. At least, not till Texas returns to normal or the OPEC agrees to boost production.

For India, it is a double whammy. Monthly trade deficit has scaled $15 billion in the last two months and with an 85% reliance on oil imports, this could worsen. That is a grim macro statement. The bigger challenge is the impact on retail fuel prices. Petrol has already crossed Rs.100/litre in many states and its direct and downstream impact on inflation cannot be ignored.

3. After the budget euphoria, it is reality check

Even after this fall, the Nifty is still 1000 points above the Union Budget level. This correction is more of a reality check. The 9.5% fiscal deficit and Rs175,000cr divestment target looks great on paper. The bigger question is; how will they stack up in practice and how will rating agencies react when they actually see 9.5% fiscal deficit. These are still hypothetical, but traders have started to ask these questions.

4. Above all, the market fall is about rising bond yields

Rising bond yields are not just a problem for debt markets. They have a profound impact on equities. Even as US bond yields are rising, the chart below captures how Indian benchmark 10-year bond yields reacted.

Data Source: RBI

The above chart clearly shows the bond yield movement since Jan-21. But the real area to watch is the sharp spike in bond yields since 15-Feb after the central government failed to find buyers for its bond issues at low yields. Whys is this spike important for markets?
a) It is a signal that rates could harden or that inflation could move up. Both are negative for stock markets.

b) Higher bond yields mean that the borrowing cost for corporates goes up. This problem is more pronounced for mid-caps and could negate rate cut efforts of the last one year.

c) Lastly, rising yields are negative for stock market valuations just as falling yield are positive. That is what is actually leading to a normalization of valuations.

A lot more clarity will emerge once the government succeeds in capping bond yields at 6% as promised. If that happens, it could give a reason for the bulls to make their presence felt once again.

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