COMMENT - Karnataka (almost) done, here are 3 red flags for markets

The Indian equity market is in a state of perplexity. A day before the result of the keenly fought and noisy Karnataka elections was announced, the Nifty closed near the 10,800-mark. On counting day, early trends showed a clear majority for BJP, which was reflected in a 130-point gain for the Nifty and nearly 400 points on the Sensex. However, as counting progressed and it was clear that the BJP would not get a clear majority, markets slipped to close at the same level as they did on Monday.

There are three takeaways from the fractious Karnataka poll, which, at the time of writing, has yet to yield a clear result.

Close battles lie ahead: The results show that defeating BJP will not be easy for the Congress or most other state parties, at least not in the near future. A combined opposition is now more a possibility than it was after the Gujarat elections.

It seems that collectively the Congress and HD Deve Gowda led JD(S) have managed to pip BJP in the final count. This model may most probably continue in other states and the rest of the country until the general elections.

That being the case, the market will be more volatile as it will sense the 2019 elections will be a closely-fought contest. Uncertainty is not something that the market will be comfortable with. Many would prefer to stay on the sidelines rather than commit more money.

Weak rupee hints at a weak market: The rupee is just below the 68-mark against the dollar. Rising oil prices, higher domestic inflation, and an increasing current account deficit are all making the rupee weaker. Foreign investors, both in equity and debt markets, have been fleeing the market. In the current fiscal FIIs have sold nearly Rs 28,700 crore in both markets. A weak rupee is a dampener for FII investments. Rising yields in the US are also making the US dollar stronger against most other major currencies.

Rising bond yields: Interest rates are rising globally. The US 10-year bond has already crossed the 3 percent mark. European rates have shot up after a European Central Bank (ECB) official hinted that they may increase rates sooner-than-expected. Indian bond yields too have risen to the highest level since February 2016 at 7.83 percent.

RBI’s latest bond auction of shorter tenure paper has not found any buyers proving that investors are looking at higher rates going forward. Reports suggest that some members of RBI’s monetary policy committee are contemplating higher rates. High-interest rates are generally bad for the markets as they increase the cost of operation for companies, which results in lower profit.

Markets have over the last few years proved that they have a tendency of defying fundamentals. Money flow was the main reason that fuelled markets globally. But then, that does not mean we should ride the market rally with our seatbelts off. Red flags are clearly visible, it’s time to decide whether we should buckle up or throw caution to the winds.