Fundamentals are improving – why is the stock market still correcting?

Are the fundamentals really improving? The short answer is: Yes. Let us look at some facts:

1. WPI inflation dropped to its lowest level in 5 years. CPI inflation also dropped - below 6.5%. The primary reason for this drop is lower food prices – which is not due to any monetary action by RBI or fiscal action by the government.

However, there is no denying that inflation is moderating, which raises the prospect of an interest cut by RBI sooner than later.

2. Commercial vehicle sales have picked up in Sep. ‘14 after 16 months of decline. That is a clear sign of a turnaround in the economy.

Passenger vehicle sales dipped slightly in Sep ‘14 – but that is probably due to seasonal reason. Dussehra, Eid, Dhanteras, Diwali are being celebrated in Oct ‘14 – an ‘auspicious time’ for vehicle buyers. Purchases may have been postponed in Sep ‘14.

3. Oil prices have fallen significantly – due to oversupply in the international market. India’s oil import bill has come down. Petrol price has been reduced. Expect a cut in diesel price soon. This will help in curbing inflation.

4. The trade deficit has narrowed by 8.2% during the first half of the year (Apr to Sep ‘14) compared to the same period last year – despite a sharp jump during the month of Sep ‘14 due to a big increase in gold imports.

In US Dollar terms, exports grew by 6.5%, while imports grew by 1.6% during Apr to Sep ‘14.

5. Despite a surge in the Dollar index, the Rupee has been relatively stable in the 60-62 range against the US Dollar. Infosys has already declared good Q2 results. Expect other large IT players to also show improvement in top and bottom lines.

The macro fundamentals are definitely better than a year ago. To answer the larger question, one needs to remember the famous quote from Benjamin Graham, who is considered the ‘father’ of value investing:

“In the short run, the market is a voting machine but in the long run, it is a weighing machine.”

What it means is that sentiments rule the market in the near-term. Why are sentiments bearish now? The main reason is selling by FIIs. Despite record inflows into Indian mutual funds, DII buying hasn’t kept pace with FII selling.

Why are FIIs selling? There has been some disappointment with the lack of speed of the Modi government in implementing much-needed reforms in financial and labour sectors. Declining growth in China and Germany, and a likely hike in interest rate in the USA have also caused a more cautious approach by FIIs.

Eventually, the market will ‘weigh’ the improving fundamentals, and the stock market will resume its up move and touch new highs. The question is: When?

How about from Mon. Oct 20 ‘14? Exit polls indicate a possible sweep by the BJP in the just-concluded state elections in Maharashtra and Haryana. Results will be declared on Sun. Oct 19 ‘14.

Government formation by BJP in both states may be just the positive fillip the stock market is awaiting.