What's leading the stock market rally?

Thu, 14 Oct Pre-Open

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Every stock market rally has its leaders and laggards – sectors that lead the broader rally and those that lag it. Even the current rally that started in March 2009, when the Sensex was just above 8,100 levels, has its leaders and laggards. This article talks about the former, i.e., sectors that have led the rally at different stages. As seen from the chart below, realty stocks led the Indian markets' rally from its lows of March 2009 to the time when the BSE-Sensex touched the 12,000 levels in May 2009.

Data Source: CMIE Prowess

From then onwards, and till the Sensex touched the 16,000 levels, it was again the realty stocks that led the charge. But in the third leg of the current rally, i.e., from Sensex at 16,000 to Sensex at 20,000, it has been the banking sector that has surpassed the gains made by all other leading sectors.

So, let's talk about what has made banking stocks tick recently and where do they go from here on.

A large part of the gains made by banking stocks came after the second week of September. This was the time when the Basel Committee on Banking Supervision, representing regulators from 27 nations, more than trebled its capital requirements for banks. But this move was less stringent than what was feared by the global and Indian banking industry. Also, what cheered investors in bank stocks was that the committee gave banks a long eight years (January 2019) to comply in full to these (Basel-III) norms.

These measures were part of the committee's efforts to prevent future financial crises. Now, what this extension of compliance timing will do is let the banks do away with the need to raise fresh capital. And it would also be valid for Indian banks. But what now remains to be seen is whether global banks take some cues from this extension and try and repair their balance sheets rather than creating another financing bubble.

The mid-September period also saw the RBI announcing its review for the monetary policy for 2010-11. And as anticipated, the central bank raised key interest rates. But what was interesting to note was that bank stocks continued to gain even after the RBI's announcement. Generally, when the central bank announces a rate hike, banking stock take a hit as higher rates are expected to weaken demand for home and auto loans. Also, higher interest rates push up yields thus eroding the value of banks' bond portfolio, and forcing them to book mark-to-market losses.

Considering these aspects, the rise in banking stocks despite RBI's rate hike announcement came as an interesting observation. One reason for this could be that Indian banks are now hoping that the RBI is done with its rate hike policy and will maintain a neutral stance going forward. But this is just a probability, and not a certainty. After all, high inflation continues to rule the roost. And increase credit offtake, which is expected by most economists, is only going to add fuel to this fire.

Data Source: CMIE Prowess

Anyways, what looks certain now is that valuations of banking stocks do not have much headroom to go up from here on. At least the fundamentals do not justify the same. With little upside in margins, Indian banks are expected to rely heavily on their fee income generating abilities in addition to their operating leverage. Also, most banks envisage higher loan restructuring and provisioning costs in the next fiscal (FY12), which may eat into their profits.