Is Inflation a big worry for equity markets?

Markets continued to remain under pressure for most of the week; they did try and regain some lost vigor but failed. Despite the reassurance from Fed Chairman Jerome Powell on inflation and employment being under control and well below targets, investors continued to sell. Rather, any comfort provided by the Fed was disregarded and technology stocks started to tumble.

An instantaneous rise in 10-year bond yields to1.6% intensified apprehension over inflation which led to the sudden jerk in US indices. As bond yields continue their upward journey, FPIs may turn away from Indian equities and towards the States for higher returns.

This stance may negatively impact emerging economy currencies (especially rupee) which would depreciate on rise in demand for the dollar. However, this could play out eventually in the future. At present, bond yields haven’t touched worrisome levels and this appears to be a small correction in the bull party.

Till the time inflation increases and is mild equities will improve, of course with corrections. Inflation can be looked at like a burning flame, as long as the flame is low there is no harm but if the flame intensifies there could be risks of getting burnt.

Global rise in commodity prices are also adding to the looming inflation worry. The increase in commodity prices would translate into higher manufacturing cost which in turn would lead to rise in CPI. Our 10-Year bond yields have moved in tandem with developed nations and these have shown mild inflationary tendencies. RBI’s MPC framework is well suited as long as the inflation remains between 4% +/- 2%. But any astonishing rise may lead to tightening of interest rates.

Gold, an inflationary hedge, is currently at its support levels and is not sending out any warning signals related to unusual inflation hikes. Therefore, investors should not be worried about inflation and keep an eye on bond markets for now.

Event of the Week

India is deliberately focusing on increasing manufacturing and employment by extending Production Linked (PLI) Schemes to various sectors unlike the US which is augmenting growth by lump sum stimulus. The PLI schemes claim to offer SOPs and cashbacks, aid exports to extend support and encourage the Make in India initiative.

These initiatives would strengthen the asset creation cycle in our country and jump start the GDP recovery. The Government has already approved PLI schemes for electronics, tech, autos, telecom etc. and in the current week these benefits got extended to pharma and IT hardware with over Rs 22,000 crore worth of sops bolstering exports. Over time, with these initiatives, India can emerge as a global manufacturing hub with cheap labour which would propel the economy as well as the stock markets.

Technical outlook

Nifty50 index closed negative, confirming the bearish engulfing pattern formed the week earlier. Since Nifty remains overbought, confirmation of the bearish signal with a bearish evening star on the daily chart does indicate further caution. Markets have also breached the immediate support of 14,630 and Nifty is likely to decline further till the next cushion support at 14,250 in the short term. Therefore, traders are advised to remain light on the long side.

Expectations for the Week

Going ahead, equity markets could remain under pressure as the normal course of correction continues to take shape. Now with expectations of a fresh stimulus in the US there could be more helicopter money in the system. However, how many more liquidity infusions will be needed for the economy to stand on its own only time will tell.

Meanwhile, market participants should keep an eye on bond yields and the movement of USD/INR which could undergo some depreciation. Investors in need of liquidity could book profits from certain stock pockets but long term investors should continue to remain invested. Nifty50 closed the week at 14529.15, down by 3.02%.

(The writer is head of equity research at Samco Securities, views expressed are personal