The domestic stock markets have been volatile. Both internal and external factors are having an impact on the markets. The markets are no longer insulated. Any development across the globe has an impact on the domestic markets.
FII funds
Foreign institutional investors (FIIs) are dominant players in the domestic markets. Their funds' inflows and outflows affect market sentiments. The FIIs invest or sell here based on their global strategies, and the macro and micro economic factors here. It is in this context that you need to understand the reasons behind the volatility in the markets.
Inflation
Internally, a significant factor affecting the markets is inflation. It is affecting corporates due to the increased costs, higher prices and lower sales volumes. The continuous interest rate increases by the Reserve Bank of India (RBI) is another factor. This has led to an increase in interest costs for the corporates. So, the profits of leveraged companies are directly affected.
The spurts in stock prices have been due to increased buying by mutual funds and individual investors.
Greece crisis
The Greece crisis looms large. If Greece does not default on its sovereign debt, it will help renew confidence in the single currency. The central banks have warned that a default by Greece, on the other hand, could trigger a turmoil that will be worse than the collapse of the US investment bank Lehman Brothers. So, all efforts are being made to avoid a default.
The recent market buoyancy has been driven by a firming trend in other Asian bourses following gains in the US markets after the Greek government won a crucial confidence vote as it struggles to pursue reforms critical for a new Euro zone bailout package. As a result, the Euro stabilised and Asian shares rose.
Debt attractive
Internally, with debt offering good, assured returns, a substantial portion of investments are being diverted to debt instruments. Fixed deposits have come out as favourites. There is an inverse relationship between interest rates and bond prices. When the interest rates go up bond prices go down, and vice-versa. Bonds with a long-term maturity are more sensitive to rate changes. Rising interest rates have caused the prices of existing bonds to decline because recently-issued bonds carry higher rates, which push down the value of previously-issued securities.
You should avoid investing in income funds or gilt funds unless you have a time horizon of more than two years. Bonds with a short term generate good returns, so you can switch your investments from long term bonds to funds with a shorter term and average maturity.
There is a slowdown in infrastructure and investment spending on the back of liquidity constraints and also high interest rates. According to analysts, the valuations in India are now looking attractive. These valuations offer a good entry point for long term investors.
Monetary policy and monsoon relevant
The main concern for India is inflation. The RBI has not been able to rein in inflation. Inflation rose higher than expected in the month of May. The Wholesale Price Index (WPI) rose an annual 9.06 percent, forcing the RBI to tighten the monetary policy further, and at the same time arresting the growth rate too. Higher borrowing costs, rising input prices and strict banking rules will make it hard for companies to get credit and in turn impede production activity, going forward.
The course of the monsoon will be a major factor affecting the inflation rate as well as the markets. With agriculture and many industries being directly or indirectly impacted by the monsoons, this will be a crucial factor this year.
FIIs are waiting to see how things move before entering the markets again. Once the situation improves and the FIIs regain confidence, the inflow of funds is expected to go strong again.
