We all know that Indian equities have been among the best performing asset classes for 2014. The BSE-Sensex, the BSE Mid Cap index and BSE Small Cap index have offered 30%, 54% and 68% returns in the year till date. While the new Government and some steps towards reforms have been a major game changer for stock markets, a major share of these gains is due to high liquidity and expectations in the improvement in earnings. As far as earnings growth is concerned, the current stock markets seem to be factoring that in already, even as major reforms are yet to be implemented.
However, going forward, as oil rich nations face lower realizations and US is expected to increase interest rates, we will not be surprised to see the liquidity factor weakening. And the latter will impact not just the equity markets. A potential hike in US interest rates and outflow of foreign funds will make Indian rupee and bond markets highly vulnerable as well.
Another factor impacting bond markets will be the domestic interest rates. While RBI's tone seemed dovish in the last policy announcement, it might wait for the government's action to tame inflation before cutting rates. Further, the move will depend on global factors like Fed rates and oil prices.
In 2014, factors like falling oil prices and their positive impact on Government's fiscal health and foreign reserves, easing inflation, and growth expectations made the Indian debt market very lucrative for investors.
However, what happens to Indian debt markets in 2015 will depend not just on inflation, exchange rates and interest rates in the economy but also global economic and political factors. Many of these are hard to predict. Hence, we believe investors would do well not to speculate on the same and instead should focus on maintaining a well diversified portfolio across asset classes.