Stern warning by RBI: Markets must read the signals

RBI has finally decided to take on the inflation menace head on, and our markets must take cognisance of the essence of the stance taken by RBI. Despite the lip service by the Govt. in taming inflation in the past, inflation has moved from strength to strength in the past 18 months. The recent move by RBI should be seen as a very positive move to fight inflation, even at the cost of sacrificing a bit of growth in the short term. The hike of 50 basis points in Repo and Reverse repo rates announced today will be the main driver for the markets in the short run.

Bond yields have firmed up to 8.44% immediately after the announcement of rate hikes. Equity markets have also reacted sharply on the downside, shrugging the unwarranted euphoria of the past few weeks. The hardening of interest rates is bound to have a negative impact on the overall corporate earnings for FY 2011-12. The equity market valuations will be re-rated downwards in the weeks to come. The chances of an imminent crash in equity markets are fairly high given the overall global uncertainty. The major indices, which have been range bound for last 6 months, are likely to break the range on the downside in the coming 1-2 months. The correction could be in the range of 15-20% from the current levels. What should the investors do in this scenario?

• Long term investors can hold on to their stocks, if liquidity is not a concern.
• The market reaction to the monetary policy should be utilised to get rid of stocks that have come out with poor results. Stocks with high exposure to debt should be avoided.
• Investors who lack liquidity may sell at least 25% of their portfolio to generate cash, which can be utilised to buy the same stocks at lower levels, when the markets react.
• The focus should be on creating a buying list of stocks that have come out with good results, so that they can be bought on dips.
• The 'Risk-reward ratio' at the current market levels is not attractive for fresh equity investment. If one is looking at a one year growth of 20% or more in the portfolio, which an equity investor should look at, one should look for investment in the range of 4800-5000 levels on the Nifty, for a target of 6000 and above in one year.
• Interest rates on deposits for shorter tenures will see significant hikes in the near future, it may not be a bad idea to put some money in fixed deposits/ bonds for the next few months.
• Profit booking may be done at any bounce in the markets, in the range of 5600-5700 on the Nifty, which is the upper end of the current range.

The next few weeks are likely to see testing times for equity investors. Investors are expected to hold their nerves in the falling markets, and take a decision to invest in equity markets for long term when markets react on the downside. The Indian economy is likely to bounce back strongly in 6-9 months time when the inflation will be tamed and interest rate cycle peaks out. Remember, the 'Mother of all bull runs' is yet to unfold in the Indian equity markets, let us get ready for it.