Concerns over stimulus withdrawal?

Thu, 7 Jan Closing

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Although the markets managed to recover from the day's lows during the closing hours of trade, it did not prove enough to get them back in the positive territory. Thus, while the Sensex closed lower by around 85 points today (0.5%), NSE Nifty edged lower by around 20 points (down 0.4%). BSE Mid cap and Small cap indices showed divergent trends today with the former ending mostly flat and the latter closing higher once again and recording gains of 0.7%. More stocks declined as compared to the ones that gained on the Sensex today, with the advance to decline ratio coming in at 1:3. Auto and IT stocks caused the maximum damage.

While most Asian indices closed lower today, the European indices are also trading in the red currently. The rupee was seen trading at Rs 45.7 to the dollar at the time of writing.

Worldwide, inflation seems to be on the rise. And this seems to be the key reason behind today's profit booking. If the trend persists going forward, it could lead policymakers to act sooner than expected. And this could result in stimuli withdrawal, both monetary as well as fiscal, thus hurting economic growth. What more, if there is too fierce a withdrawal, there is every possibility that the global economy could again fall back into a recession. The irony is, no one knows for certain what should be the correct magnitude of withdrawal so as to not hurt the recovery process a great deal. Investors, on their part, do not want to take any chances and seem to be taking partial profits off the table. After all, they have made tons of money since March 2009 and no one has ever gone broke booking profits!

Although it continues to remain well over the government's comfort levels, food inflation softened to 18% in the previous week from the 20% figure touched earlier. As the officials in Finance Ministry debate whether to withdraw the fiscal stimuli, containing inflation remains high on their priority. Given the rise in rural income and shortage in food supply due to irregular rainfall, the problem of food inflation is unlikely to be resolved soon. Meanwhile, rise in commodity prices are also stoking inflationary concerns and heightening the possibility of monetary tightening. All eyes are therefore on the upcoming monetary policy and Union budget to know the government's stance on future economic direction.

IT stocks had yet another weak outing today. Major losers here included TCS, Wipro, and Infosys. Continued appreciation of the rupee against the US dollar seems to be the biggest reason for investors' sore sentiment towards IT stocks. The rupee today gained for the fourth day in a row thereby sparking fears that IT companies' profits might come under strain in the coming quarters. An appreciating rupee affects IT companies' margins. This is because every dollar earned can then be converted into lesser number of rupees while the rupee costs for these firms do not change much. With economists expecting the rupee to strengthen further on the back of rising foreign fund inflows, profits of IT companies can take some hit during the coming quarters. But that doesn't change our long term outlook on the sector, which is positive. We believe that the value proposition for IT offshoring remains strong and this will benefit the right kind of companies from the sector over the next 5 to 10 years.

Pharma stocks closed mixed today. While Wockhardt and GSK Pharma found favour, Ranbaxy and Dr.Reddy's closed in the red. As per a leading business daily, domestic pharma major Ranbaxy is said to be in talks with a privately held Bangalore based vaccines company. While Ranbaxy has not confirmed the same, the deal could be valued around Rs 500 m. Given that Ranbaxy has no presence in the vaccines segment, the rationale behind the same could be to augment its product portfolio in the domestic market. The vaccines segment in recent times has garnered interest from several players due to the opportunity from immunization programmes, government tenders and focus on prevention of diseases such as hepatitis and cancer. Interestingly, Ranbaxy had made a string of acquisitions in India in the biotech space to gain a foothold in this lucrative field. However, so far Ranbaxy has not been able to generate significant value from the same what with Daiichi Sankyo acquiring a majority stake in the company and the US FDA issuing warning letters with respect to two of its manufacturing plants. The company at present trails Cipla in the domestic market and it remains to be seen how this acquisition if it takes place adds further value to Ranbaxy's domestic business.