Mr.Market has been selling through the first half of 2011. Nothing seems to restore his confidence in the market and recent events seem to suggest the possibility of further sell-offs in the near term. What are the factors that are weighing on Mr.Market’s mind ? And, how will these factors play out in the rest of 2011 ?
Rising commodity prices and uncontrollable inflation were the primary factors which triggered a reversal in market sentiment in 2011. The surge in commodities hit the consuming economies like China and India very hard. Inflation surged beyond control leaving the central banks of these countries with little option but to hike interest rates. Even several rate hikes later , inflation shows little sign of abating and even the central banks are not talking of inflation falling quickly. This essentially leaves central banks like RBI with little option but to hike interest rates further. This will definitely hurt growth in the near term and Mr.market only knows it too well.
High commodity prices and particularly high oil prices hurt importing nations like India significantly. High oil prices tend to throw the country’s subsidy bill out of gear and take the country’s balance sheet deeper into deficits. These concerns have turned FII’s into sellers in India and the indices have remained weak. Rising interest rates have shaken the sentiment in banking and housing sectors as global investors began to factor in further rate hikes by the RBI in its battle against inflation. In this scenario , the sudden fall in commodity prices have come a surprise to investors. Oil has fallen when nobody expected it to and is showing some signs of weakness. Yet ,the market seem to be cautious in its response to the correction in commodity prices because of two reasons. The Indian indices are commodity-heavy and any fall in prices may tend to hurt earnings of the index heavy-weights in the near term. Further , the commodity user industries will be hurt by the rising interest rates as consumption may slow down if credit becomes even more expensive. Therefore, these industries will benefit from falling commodity prices only when interest rates soften and when commodity prices remain stable over longer periods of time. In the interim period , earnings of companies which are commodity producers and commodity users may witness strain in the absence of favorable economic conditions. The banking industry which has been a significant contributor to every market rally has also fallen sharply in recent weeks. Markets always tend to buy banking when interest rates fall or in anticipation of a fall in rates.
In this scenario , all factors seem to be loaded against market sentiment reversing quickly and this seems to be working on Mr.market’s view as well. It is likely that Mr.Market may go through yet another phase of indecision , negativity and pessimism. But, intelligent investing is not about going along with whatever Mr. Market thinks is the right thing to do. When Mr.Market is weighing his decisions solely on market sentiment, the intelligent investor must let valuation rule over his investment decisions. In my view, there are enough value opportunities out there and more bargains are emerging with every correction.