US Fed ends ZIRP. What happens now?

Mon, 21 Dec Pre-Open

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Unless you've been living in a cave, you have probably heard about the interest rate hike by the US Federal Reserve. But why is this significant? Central banks increase and decrease interest rates all the time. That's part of their job after all. While this is true, there can be no doubt this particular rate hike will be remembered as a historic event.

The reason is simple. In 2008, the US economy slumped into its worst recession since the 1930s. The Fed responded by cutting the benchmark interest rate, the Federal Funds rate, to zero in December of that year. It has remained at zero until now. The zero interest rate policy (ZIRP) finally ended on 16 December 2015.

It was the first rate hike in almost nine years! The Fed has signalled a gradual pace of rate hikes in 2016. But the normalisation of US interest rates could take as long as 2019. Clearly, global markets will take some time to come to terms with the reality of a rising interest rate environment.

So what about the Indian stock markets? The initial reaction was muted as the move was along expected lines. But now that the event has passed, can we expect markets to move higher? It would be difficult in our opinion. Even without this overhang, Indian markets don't have any trigger to take them higher.

Here are just some reasons for caution.

Earnings growth has been dull. The pace of economic reforms has been slow. The monsoons have failed for two consecutive years. There's a logjam in Parliament. The Modi euphoria has died down. Exports have crashed. Credit growth remains poor. Corporates are not excited to invest and build capex right now. The NPA menace in the banking system won't be resolved quickly.

By and large, the Indian economy has been saved by falling commodity prices, specifically crude oil. Thus, it would be foolish to expect a surge in Indian markets just because this one event is now behind us. Valuations too, are not supportive. As historic as the US Fed's rate hike was, investors should not let such events cloud their judgement. As long-tem value investors, we recommend a sound bottom-up approach to stock picking, one that is based on company fundamentals and stock valuations.

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