Why it makes sense to square off long positions in this market…

As the markets enter a critical expiry week, the key question is whether the strategy for traders should be on the short side or the long side. If one tends to look at a mix of domestic and global macros, the immediate conclusion would be that the negatives in the environment far outweigh the positives in the current environment. Consequently, it will make a lot more sense to lighten long positions in the market. More so, if these positions are short term trading positions or if these positions are leveraged in the derivatives market. Let us understand why!

Domestic macros leave a lot to be desired…

On the domestic front, macros have not been too encouraging. Food inflation is once again rearing its head. First it was onions, then it was pulses and now it is tomatoes. Structural issues pertaining to logistics and infrastructure will ensure that these price anomalies will continue. The consumer inflation has already touched 5% and it is very close to the RBI comfort level. That is not great news. Secondly, domestic macros with respect to trade have been quite disappointing. To begin with exports have continued to show a negative growth for the 10th month in succession. For the year, the overall trade is likely to contract by over 20%. IIP growth has taken a serious hit in the last month and at below 4% it raises serious doubts about the government achieving its 7.5% GDP growth target. Also the recently announced 7th Pay Commission dole out will increase the fiscal deficit by 0.5%. In a nutshell, domestic macros are far from encouraging at this point of time.

Corporate level data is also not too encouraging…

The second quarter just concluded has been quite disappointing and the flat to negative trend of growth continues for the fourth quarter in succession. Already consensus estimates for 2016 have downgraded the Sensex EPS closer to Rs.1400. At the current level of the Sensex, there is little margin of safety that is available. This quarter, even the defensive sectors like FMCG, pharma and IT have faced the pressure of falling rural demand, weak global demand and tighter market conditions.

Bank lending data too has been discouraging. In fact, bank lending has grown by just 8.4% in the first 6 months and manufacturing sector has actually seen a negative growth. This a serious concern because it has happened despite the repo rates being cut by 125 basis points by the RBI during the year. That clearly shows that lower rates are not getting transmitted and therefore not translating into higher credit. That could mean the RBI would wait and watch ahead of further cuts.

Then there are the global worries too…

When we talk of global worries, our minds naturally veer towards the Fed decision on rates. The colour of the data coming out from the US and the language of the Fed governors seems to indicate a willingness to hike Fed rates. Whether it happens in December this year or in early 2016 is more of an academic debate. The reality is that the FOMC is closer to a rate hike than at any time in recent memory. That by itself is enough to harden bond yields across the globe and also to trigger portfolio outflows from emerging markets. That is evident from FII numbers in November 2015.

There are two additional global concern points. China is showing clear signs of slowing closer to 6%, even as unofficial estimates put China’s growth at closer to 5.5%. That will have serious implications for the demand for commodities and oil in the coming year. Also there are a slew of trade blocks that are under consideration. There is a Pacific Trade Block and there is also a Trans-Atlantic Trade Block. Both could seriously impair India’s efforts to push up its trade. In a year when exports and imports have been so weak, this is not great news.

All corporate exemptions may go as scheduled…

In the last Union Budget, the Finance Minister had agreed to cut corporate taxes from 30% to 25% in 4 tranches over 4 years. But this also entailed the removal of all kinds of exemptions including asset related exemptions, capital allowances, depreciation benefits, backward area allowances, hilly area allowances etc. This is not great news for Indian companies who have managed to maintain a low tax payout due to the plethora of exemptions available in the Income Tax Act. Most of the capital intensive companies have typically paid much lower effective taxes due to the benefit of these exemptions. The worry is that the withdrawal of these exemptions will more than offset the benefits of a reduced corporate tax rate. This will be the one factor that will weigh negatively on markets in the coming weeks.

The moral of the story is that it may be time to lighten your positions in the market. Trading positions that are trying to ride on momentum and leveraged positions in the F&O space must be either squared off or kept as light as possible. Of course, we are referring to positions on the long side. The current combination of domestic macros, global macros and the news flows has not been too conducive to the sustenance of a positive market trend. Better safe than sorry!

You can ask us your stock related questions with #AskReligareOnMarkets via our Twitter channel @religareonline

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