High Inflation - Likely Market Impact

On 8th April 2010 we were at 18000 points on the sensex. Today on 14th June 2011, we are again close to 18000 points. In otherwords, the indian stock market index has grows by a mear 1.66% over a period of 14 months. Thanks to host of worries and negative news that held the index static for such a long duration. And we may have more surprises in the next few weeks.

Let us understand a few of them:

(1) Today India's Inflation rose to 9.06% in May 2011 when compared to 8.66% in April 2011. And there are fears that it may touch double digit in next few months.
(2) China hiked its interest rates by 0.5% to contain its inflation which has been rising for the past 34 months.
(3) Thanks to Libya and unrest in middle east, Oil price remains high @ US$120/barrel. With 90% of oil consumed is being imported, india faces high oil price.
(4) After much delay, post state elections, Petrol prices were hiked. But the government is still not confident of hiking the diesel price and cooking gas price. Once that is being done, inflation will run up further, fuelling further inflation.
(5) Given these situations RBI would hike interest rates much higher.
(7) And there are the huge Foreign Currency convertible bond repayable by many indian companies in the next 12 months.
(6) Added to these are global uncertainities like Greece being dumped as likely candidate of defaulting and US president Obama quoting "Debt crisis could trigger new economic meltdown"

Likely impact on Stock Markets:
(1) Higher inflation / Higher interest rates are deffinitely not good for - economy / citizens / stock market.
(2) In the first place, due to higher cost people would be left with lesser money to spend. That means lower consumption and lower sales by companies resulting in lower profitability. Hence all these companies share prices may not fare well till such time inflation is higher.
(3) Higher interest rates badly affects credit dependent industries like automobiles ( 4 wheelers ), capital goods, housing etc. Hence, it is better to avoid them till such time interest rates are higher.
(4) The glamour for Real estate has always been with indians, but not for the Real estate companies who are already debt ladended. The current rising interest rate scenario may squeeze them even further throwing wonderful opportunity to pick them at fraction of their peak price.
(5) Though banks which pay higher interest rates for their deposits could charge higher interest rates on their lending, due to falling demand for credit there is greater possibility of idle cash. As a result bank's profitability may be hit.
(6) The inflation figures (9.06%) has so far captured only the petrol price hike. When diesel prices and Gas prices are hiked, inflation are certaily bound to hit double digit. And diesel price hike is directly linked to cost of truck transport resulting in higher vegetable prices. And don't forget the likely lorry stike demanding roll back of diesel price - resulting in even higher esclation of vegetable prices.

All these fact put together indicate few simple things:
(a) Now is not the time to buy / invest in shares.
(b) Any rally in stock market can be used to exit existing investments at profit.
(c) It is wiser to accumulate cash and be ready to invest when everyone sells.

But exemption is always the rule. Few sectors / stocks may stand out and perform. Some of them could be:
(i) Retail Sector companies like Pantaloon,. With strong possibility that Government may hike FDI limit and allow foreign companies to participate in indian retail industry, most of the retail companies may deliver positive returns inspite of sluggish market conditions.
(ii) Same is true for Insurance industry. With possible FDI hike in insurance sector, many insurance companies may open up with IPO's or benefit from subsidaries. Analjith Sing's Max India is the only pure insurance company which is listed in india. Apart from that you do have Rel Capital etc. All of them may benefit
(iii)Pharma companies may benefit due to huge number of drugs going out of patency. Indian drug companies like cipla are mostly mass drug producers who are likely to benefit immensely.
(iv) Few NBFC's companies may get RBI licence to convert themselves into bank. Such companies may also hold out.

To sum up:
(1) You need to be stock specific while investing in shares.
(2) You need to be patient in deploying your funds. It is better to invest in parts.
(3) High risk takers may take the contrarian bets like the exception items given above and make higher returns, though at higher risks.