Devangshu Datta: Earnings report card a deciding factor

Global equity markets have rebounded with enthusiasm after the initial shock of Brexit. However, the mood is more sombre in the bond, currency and commodity markets. Traders are waiting for the earnings season to kick off and for news flow out of multiple central bank meetings.

The political news out of the UK remains confusing. After all the resignations, there will be a new prime minister for sure and she will have to initiate the exit. The property market is freezing up. The GBP has dropped by about 14 per cent versus the USD. Even the euro is up 10 per cent versus the GBP although it is down versus other currencies. There is still a surprising amount of optimism, given that most commentators think the UK is headed for economic contraction.

The news out of the USA is good. That’s been a prime factor in driving stocks up. US labour data shows 287,000 non-farm jobs were created in June. Overall, this implies that the US economy is doing well while at the same time, the US Federal Reserve is reckoned unlikely to raise rates soon due to Brexit.

The Fed attitude in the July 26-27 meeting will be parsed in great detail. The European Central Bank and the Bank of Japan (BoJ) also have policy meetings around that time. Prior to that, the Bank of England’s (BoE) Monetary Policy Committee meets this Wednesday (July 13). The Reserve Bank of India (RBI) follows up with a policy meet in early August.

Traders are expecting “favourable” outcomes. That is, central banks are all expected to turn the taps open a little wider. Whether extra liquidity will be pumped out and whether such excess liquidity will actually stimulate growth, if it does happen, are both moot points. The world is already awash in liquidity and more might not make a difference to the real economy though it will push equity values up.

The BoE has effectively a zero policy rate (nominally at 0.5 per cent) and it needs to worry about the GBP nose-diving. However consensus suggests there may be a quantitative easing of some description from the UK.

The European Union has a negative policy rate and an ongoing bond-buying programme. The BoJ has a negative rate and a full-fledged quantitative easing programme. The Fed hiked the US policy rate minimally last year and has threatened to do it again, at least twice this year. The People’s Bank of China has cut rates umpteen times already, and adjusted the yuan trading band to push it to  six-year lows.

That brings us to the RBI and its outgoing governor, Raghuram Rajan’s last policy review. Presumably the RBI will react to policy decisions taken by those other central banks. June inflation numbers will be in and so will the May Index of Industrial Production. Corporate earnings season will be in progress. There will be more clarity about the monsoon. If food inflation is under control, there may be room for the RBI to indulge in another rate cut. It will also have to take a call on where it wants the rupee to trade.

In May 2016, the consumer price index was up 5.79 per cent year-on-year. The eight core sectors saw growth slip to 2.8 per cent year-on-year in May 2016. The Index of Industrial Production saw year-on-year contraction of 0.8 per cent in April. Most market analysts expect Q1 (April-June 2016) earnings growth to remain flat.  Services Purchasing Managers’ Index was down in June but Manufacturing PMI rose.

Market watchers must take a call on the implications of the recent Cabinet reshuffle, with changes in key ministries such as finance and telecom. While the shifting of Jayant Sinha to civil aviation may be good for that sector, most analysts would have preferred him to remain in the Ministry of Finance with a brief to carry out bank reforms.

Also, while the Bharatiya Janata Party tries to project a reform-friendly attitude, it has been reluctant to actually move on key areas. Can it push through the goods and services tax (GST) in the monsoon session of Parliament? If GST does not go through now, there is little chance that GST will happen before this Lok Sabha term ends in 2019.

The upcoming spectrum auctions will also be watched with interest. The base prices assume bids of Rs 5.66 lakh crore. Those receipts are linked to Budget projections, with the government hoping to raise about Rs 54,000 crore in 2016-17 from the 2016 auctions (about Rs 45,000 crore should come from earlier dues). The latest controversy about allegedly unpaid dues by telecom service providers in a Comptroller and Auditor General report could impact sector dynamics — this is the umpteenth scandal in the sector.

Foreign portfolio investors (FPI) sold a lot of debt in June. Overall, FPIs were net-negative. Domestic institutional investors (DII) were net equity  buyers. July has started with net buying from both DIIs and FIIs. Retail also remains optimistic.

Technically speaking, the market is back in bullish mode, hitting its highest points of 2016. There is an apparent disconnect here, with valuations up in defiance of low earnings growth. But as any trend follower would say, how does it matter so long as the market keeps going up?

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