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Demonetization & Fear of Foreign Fund Outflows Pull Markets Down – November 2016 Newsletter

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Note – The delay in publishing this monthly commentary was intentional as many major events were lined up for the first two weeks of December. So to give a complete analysis of all inter-related events, we are publishing the November newsletter today.

November turned out to be a weak month for the Indian markets and all major indices ended up in the red. Infact, had it not been for the recovery in last week of the month, both Nifty and Sensex would have closed the month with cuts in excess of 8-10%.

But at the end, Nifty50 and Sensex gave closed the month with negative returns of4.65% and -4.57% respectively.

There are many reasons for this weakness. Major being concerns about slowdown due to demonetization. Then there were also worries about how foreign funds will behave as US Fed restarts it rate-increase program.

Demonetization Haunts the Economy!

There is no doubt that demonetization has caught everyone by surprise. More so, those who held a lot of unaccounted wealth and towards whom, the entire exercise of demonetization was aimed at first place.

Though it is very difficult to predict the exact trajectory of economy’s growth after demonetization, there is no question that the economy will witness temporary disruptions at multiple levels. Discretionary spending, etc. are expected to see a fall in near term. This in turn will have negative impact on companies servicing those discretionary demands.

Some agencies are of the view that economy will regain its momentum in a quarter or a little more. But as new data and statistics emerge from various sources, it is increasingly becoming clear that recovery will take longer than just one quarter.

For investors, demonetization is a short-term negative but a good move to strengthen the economy in the long term. In fact, the price correction caused by this event actually offers a good entry point for long-term investors.

Also, the government has made it clear that demonetization is not the last step against black money. There will be more measures taken in future against ‘Benami’ properties and those purchased using black money – the core of parallel economy. So there is a growing consensus that property prices will start moving down in due course of time.

Policy Rates in India

RBI surprised everyone by keeping the key policy rates unchanged in its bi-monthly meet in December.

Though there was a strong expectation of a rate cut, RBI has decided to further assess the impact of demonetization before taking a call. Another reason for the reluctance to cut rates would be eminent US Fed rate hike, which would trigger an outflow of dollars from India and weaken the Rupee further.

But in order to absorb the excess liquidity generated (due to deposition of notes with banks), it had introduced a temporary measure. The banks had to transfer 100% of their cash under the RBI’s cash reserve ratio from deposits generated between 16 September and 11 November. This temporary measure is expected to be withdrawn soon as things normalize.

As for the rate cut that everyone is waiting for, the probability is high that RBI will go for a 0.25% cut at in its February 2017 review. This is to give a boost to the slowing growth and also because the inflation is under control.

US Fed Rate Hike

As expected, the US Federal Reserve raised interest rates by 0.25%. More importantly, it has indicated that the pace of rate hikes will accelerate in coming quarters.

As the new President-elect Donald Trump is expected to announce tax cuts and increase spending on infrastructure, the US Fed now has more freedom to hike rates going forward. The long-term expectation is for the rates to reach their long-term average of 2-3% in next few years.

There is an increasing fear in emerging markets like India that the era of easy and (almost) zero-cost money is over. This is true to an extent. If Fed does increase rates as planned, then India will have to make peace with the fact that fund coming from foreign shores will reduce with time. This doesn’t mean that new money will not come to India and go elsewhere. It only means that the momentum provided to Indian markets by global fund flows will reduce in coming years.

Power Struggle continues in Tata Group

The struggle for power in Tata Group continued last month too. The Tata’s side has moved swiftly to oust Mr. Cyrus Mistry from the board of various group companies.

Though this is a temporary problem for the group stocks, fact is that it is bringing out the dirty side of both parties in open. This doesn’t auger well either for the group’s respectable image or for India’s corporate governance in general.

Research & Ranking Sidenote

Given the big-ticket events taking place last month, the volatility in markets is expected to increase in near term. But for long-term investors, there is not much to worry about. Short-term concerns remain, as they always will.

But Demonetization and GST rollout are a big positive for the Indian economy in the long run. Though the benefits of these two big developments will take time to become visible, there is absolutely no doubt that these will relaunch the economy in a bigger and stronger way.

We appreciate you for taking time to read this message. Do share your views/comments by email/comment section below.

Warm Regards,

Research & Ranking

Read more:  How Long-term investing helps create life-changing wealth – TOI.

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