Crude barrier looms, but music’s blaring

An increase in the quantity of money or fiduciary media is an indispensable condition of the emergence of a boom … There is no means of avoiding the final collapse of a boom brought about by credit expansion.  The alternative is only whether the crisis should come sooner as the result of voluntary abandonment of further credit expansion, or later as a final and total catastrophe of the currency system involved.  — Ludwig von Mises (1881-1973)

von Mises’ warning is the last thing fundmen want to hear these days, especially when the music is so on, thanks to the endless money (over $500 billion at last count) being supplied by the European Central Bank at just 1% interest rate.

But the slick on which valuations, especially those in India, always slip is casting an ominous shadow —crude is surging uncomfortably higher.

In the last five years, there have been only two occasions when Brent crude rose to $120 a barrel or more. The first time was in May 2008, when the Sensex couldn’t go beyond 17400 after surging 10% in the previous 30 days.

And in April 2011, after gaining close to 7% in the previous 30 days, the Sensex peaked out around 19700 once crude crossed $120. The index consolidated over the next one month.

Equities and crude oil have had a positive correlation, but in both the cases above, the $120 level has proved a major obstruction for Indian equities. And crude is hovering near $118 currently.
Experts, however, said current momentum is so strong, high crude prices have got priced in.

“Crude has been hovering at $100-120 levels over the last few months… Moreover, even as crude prices rose 10%, the effect has been cushioned by a nearly 8% appreciation in the rupee,” said Gaurav Dua, head of research at Sharekhan.

Anand Tandon, CEO of JRG Securities, explains the predicament differently: “Even though nothing has changed on the fiscal deficit front or any on other macro parameters, the markets are looking beyond the curve and hoping things turn out positively.”

He said crude continues to remain at high levels which may lead to the government footing a higher oil subsidy bill, but the general expectation on which the market is moving is that government will come out with a slew of reforms post Budget.

“Assuming there is no major disaster in the West, liquidity would continue to find its way into Indian markets. So, there’s a feeling that one shouldn’t argue with the trend and it’s better to go with the tide,” Tandon said.

Dua said even on the domestic front, expectations of a reversal in interest rate cycle and falling inflation have aided the sharp 20% rally.

“So, even if macros haven’t improved much, multiples are getting back to normal historic levels,” he said.

Tandon agrees: “Fundamentally, valuations are now at mid levels and there is no major headroom so the Sensex should stick around 18000 for a quarter. However, there doesn’t seem to be any major downside concerns right now,”he said.

Technically, a swing of 20% magnitude is considered the beginning of either a bull or a bear market.

Some like VK Sharma, head of private broking and wealth
management at HDFC Securities, see the seeds of a bull run being sown.

“The advance-decline ratio this time around is much better than we had in the previous instances and there has been persistent buying even on ‘bad news’ days. All these are hallmarks of a bull market. One should continue to buy on dips and for those who are looking at clear signals, Nifty 5450 would be the level to watch out for,” Sharma said.

So when will crude begin to give sleepless nights?

“If crude does appreciate by another 5-8% (to $125 or more) then it would be a problem for India and the markets may not take it positively even if the liquidity continues,” said Dua. Till then, keep an eye on the gathering slick too.