Nifty Closed In Slight Negative After Another Day’s Of Consolidation (Distribution?); But Closed The Week Almost 3% Lower Marked By Demonetization Chaos & Rising US Bond Yields (Strong USD)

Expect 7925-7675 In NF, If Closed Consecutively Below 8035; Trend Change May Only Happen On Consistent Closing above 8200 For Next Week.

Market Wrap: 18/11/2016 (17:30)

Nifty Fut (Nov) today closed around 8070 (-0.23%) after making a post noon session brief intra-day rally high of 8139 and opening session day low of 8055. With this, Nifty closed the eventful week marked by fears of an economic slowdown as a result of demonetization (surgical strike on India’s unaccounted/black economy) and rising USD for “Trumponomics” and Fed’s virtual confirmation about Dec’16 rate hike.

Indian market today opened almost flat and saw mild short covering, may be for intra basis for a brief rally and lack of any meaningful buying interest again caused it to drift lower as 8155-8200 zone in NF is now acting as a near term strong technical resistance.

Yesterday, Yellen “almost” confirmed about Fed’s intention to hike US rate in Dec’16 (0.25%) and also gave some hints about further (gradual) rate hikes in 2017 (most probably 2 rate hikes @0.25%) as a result of “Trumponomics” & expected “Trumpflation”. 

Yellen also cautioned about excessive fiscal stimulus by Trump and am unusual “hot” American economy as core inflation may jump beyond Fed’s projection, which may prompt Fed to go more rapid rate hikes towards path of normalization, keeping RRI around 1.5%. In that scenario, if core CPI surged to around 4% by 2018-19, Fed has to raise rate to around 2.5% from the present level of 0.38% (0.25-0.50%).

As par his election campaign rhetoric, Trump is expected to spend $1 TLN over next five years to “rebuild” America and this fiscal/infra spending will also be coupled with cuts in both corporate & personal income taxes, which may fuel higher US fiscal deficit and inflation.

Trump is also expected to draw a strategy for Govt & Private investments like PPP model for the overall requirements of funds for his fiscal stimulus. The overall plan may stimulate growth & consumption in US and with that additional cut in corporate taxes may also fuel US corporate earnings. That’s why we have an unusual and rare combination of strong USD & US EQ market.

Although, Yellen is concerned about "too much" inflation as a likely fall out of “Trumponomics”, some analysts do also reckon that because of Trump’s US oil policy (more pumping rather than importing) and inability of OPEC to have a sustainable production cut/freeze agreement, oil may drive lower towards $30 and in that scenario, US headline CPI may be also contained.

After unexpected “Brexit” & “Trumpism”, nationalism is on the rise in the whole EU universe and this “fight against establishment” may also cause significant political risks across EU, with several countries going for some referendum and election in the coming days (Italy, France, Denmark, Austria etc).

Thus EU political risks and divergent dovish monetary policy between Fed and ECB/ BOJ and several other G-10 economics are making USD stronger across the board and along with that, for the eventual out flow concern, EM currencies are in some types of severe meltdown.

For the last few days, several EM central banks are scrambling to save their currencies from further meltdown and today RBI also did some intervention through two large PSBS for buying support of INR. 

But despite that USDINR-I closed around 68.17, which is at multi month high and if this trend continues, USDINR can further rally towards 69-71 range (technically, if sustained over 68.30). In that scenario, FPI(s) may scramble for more portfolio sell as a weak INR may not be good for their health.

After talk of Trump’s fiscal/structural stimulus & “America First” notion, more EU nations may employ this path and we may see less talk of QQE in the coming months as ECB & BOJ are also increasingly pushing Govt for more fiscal rather than monetary stimulus as they are also going “out of arsenals” very soon.

Thus, further liquidity tap may be off and globally we may see more out flow from the EM to DM and India, being a part of this liquidity rally, may not be treated as an exception despite being a “sweet spot” in the global economy. Going forward, DM & EM may be also decoupled.

Another concern may be continuous Yuan devaluation and Chinese outflow & debt bomb. Apart from China’s own internal reason, another reason for currency devaluation may be “Candidate Trump’s” rhetoric about China as “currency manipulator” and “job snatchers from US” with a significant trade surplus. Trump may now try for “Made In America” campaign against “Made In China” and may also try block Chinese trade in US as "President".

A serious Chinese jitters may be even worse for the global financial market than a US recession. Although, China is now looking for another sea route through Gadar port in POK (CPEC) to trade directly with West Asia, South Africa & some parts of EU to promote growth in lieu of over reliance on US, this may take more time.

Back to home, apart from the strength in USD and outflow concern, Indian market is under severe pressure because of concern of slowing economic activity and its effect on GDP & earnings in FY: 17-18 as a result of Govt’s war on black money. 

As par some reports, GDP may fall towards 6.5-5.8% by FY: 17-18 and Nifty EPS may also be downgraded for an 8-10% CAGR (FY-17) instead of earlier estimate of 15-18% as a significant portion of India’s domestic consumption story is dependent on the “informal parallel economy”. The transition from “black” to “white” economy may take more time and it may take at least five years for any meaningful upturn in the viscous cycle of demand & investments. 

Ultimately, 85% of cash replacement in a vast economy & country like India is not a child’s play, where almost 80% transactions are done in “cash”. Simply speaking, the country may not be prepared for a “plastic” economy right now and this conversion from “cash economy” may take more times.

Indian market sentiment may also be affected to some extent after reports of SC, taking a tough stand against the Govt for the present chaos of demonetization. Market may be also ignoring several incremental reforms/projects announced by the Govt this week due to this demonetization overhang.

Another point is that even if RBI goes for an aggressive rate cuts in the coming months (0.50-1.00% by FY: 17-18), INR may be further devalued and FPI outflow may also increase. 

In a country, where bank & small savings rate are quite high, it may not be possible for the banks to offer lower lending rate without cutting bank deposit rates despite advantage of greater CASA at lower costs as a result of demonetization and favourable bond markets.

So, unless & until bank and small savings rate does not go significantly lower, it may not be possible for the banks to transmit full rate cuts effects to the borrowers/economy and in that scenario, RBI repo rate cuts may not make any difference for the overall cost of funds of the borrowers apart from improvements of bottom lines of the banks.

Slashing of high savings rate in India may also be politically counter-productive and not possible and no Govt will try for it.

Thus, lack of full & effective rate cut transmissions by the banks to the economy may not yield any significant improvement for the overall earnings of the corporates. Higher CASA/deposits may temporary help banks, but we may see also significant bank withdrawals once current crisis of cash shortage goes normal after 3-6 months as most of the recent cash deposits in old notes may be from house hold savings and Indian House Wives may continue like to “hoard” it at their home. 

Although overall inflation may dip as a result of such demonetization,in the long term, in the short term food inflation may spike also as supply is less than demand for lack of "cash". Real Estate prices has already began to fall but that may also pose significant risks to the entire financial system. 

No black money holder having significant amount of unaccounted/graft/illegal money will go to bank for surrender to face both 60% “loss” and prosecution. There are several other ways (leakages) with 20-40% notional “loss” to convert it into new notes or some other assets. A significant portion of that black money may be also lost and will never return to the formal system.

In order to wipe out the black money, Govt need to plug the loopholes in our system and stop the source of corruption first. Simple demonetization and then again replace it with the same or higher denomination of currency notes may not yield the expected result apart from the harassment of the ordinary citizens.

Apart from all the demonetization related debates, Govt may ensure the same size & shape (compatible) new notes for 500 & 2000 (with old 1000 notes), so that overall recalibration and replacements of new notes will be easier.

The overall costs of this demonetization may also be huge (Rs.13000-2000 Cr ?) for the Govt fiscal position and also for the banks, which may be reflected in H2FY17 earnings for them.

In any way, Govt may be quite successful to have a “fear factor” in the minds of so called black money holders and going forward, it may be even tough to transact in “cash” or even through "shadow" bank A/C and India, being traditionally an “informal black economy”, the present transition to “formal white economy” may take more times and until then, the great domestic story of consumption may take the back seat.