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Global: Fed, the wet blanket!

Jan 8, 2005

This week saw markets round the globe riding the pressure of views emanating from the Federal Reserve that the US economy is in an expansionary stage and that risks of inflation are rising. Believing that US interest rates are likely to rise faster in light of the developments as mentioned above, there was panic selling witnessed across emerging markets from the Asian region. Apart from the Dow and the NASDAQ, major losers of this 'alarming' news were indices like the Hang Seng, BSE-Sensex and the Nikkei.

Key global indices…
  31-Dec-04 07-Jan-05 Change
CAC 3,821 3,878 1.5%
DAX 4,256 4,316 1.4%
FTSE 4,814 4,854 0.8%
Nikkei 11,489 11,433 -0.5%
Dow 10,783 10,604 -1.7%
Sensex 6,603 6,420 -2.8%
NASDAQ 2,175 2,089 -4.0%
Hang Seng 14,230 13,575 -4.6%

So, who was the culprit?

The minutes of the meeting of Federal Reserve (held on December 12, 2004) were released this week. Some accompanying facts of the minutes led to investors across the world panicking in belief that the faster rise in the US interest rates will lead to the 'hot' Foreign Institutional Investors (FIIs) money reversing its flow, back towards the relatively safer US treasury bills and bonds.

The minutes of the aforesaid meeting indicated that the US economy expanded at a moderate pace in the second half of 2004, with both consumer and investment spending remaining robust. However, while core inflation remained subdued, prices rose slightly higher than in 2003. This was much owing to the indirect effects of higher energy prices. It was also indicated that the recent depreciation of the US dollar against key currencies was also putting pressure on inflation, thus increasing risks of a faster rise in prices going forward.

These key details of the Fed meeting led market participants to believe that the US central bank might raise interest rates faster than in the past, thus increasing risks of re-allocation of FII money back to US equities in 2005. Apart from that, the fact that economic policies across the globe are now more integrated than ever before, investors seemed to have believed that in light of the US Fed raising interest rates at a faster pace, central banks across the world will follow suit, thus stalling investment and consumer spending.

The fear was same in case of the Indian markets as seen by the 3% fall in the Sensex the day the minutes of the Fed meeting were released. Even Indian ADRs bore the brunt of this panic selling (or profit booking, as we may say!). Key losers from the pack were Wipro, HDFC Bank and Satyam.

Key Indian ADRs
  31-Dec-04 07-Jan-05 Change
Infosys 69 66 -4.9%
Tata Motors 12 11 -5.2%
Dr. Reddy's 20 18 -7.3%
ICICI Bank 20 19 -7.7%
Satyam 24 22 -8.2%
HDFC Bank 45 41 -9.8%
Wipro 25 22 -12.7%

What should Indian investors do?

In light of the concerns that have been mentioned above with respect to FII flows reversing their direction, thus leaving local investors in the lurch, we suggest that investors should not bank on just FII inflows to drive markets to new highs. Also, given the sharp rise over the last two years, investors have to be cautious when it comes to investing in equities at the current levels. Apart from the fact that return expectations needs to be toned down, investments need to be staggered over a period of time. Happy investing!

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