US labour data flashing warning signs, Fed rate cut may provide some support to the market: Nuvama
New Delhi, India: The Indian stock markets are on the brink of entering a new phase, marked by potential rate cuts from the U.S. Federal Reserve, highlighted a report by Nuvama.
The report noted that while economic theory often points to such cuts providing a boost to equity valuations in India but the historical data presents a more nuanced picture.
As per the report in 2001, after the Fed initiated rate cuts, India's Nifty index saw a significant decline of 35 per cent. A few years later, in 2007, the market experienced an initial surge, only to plummet by 60 per cent in 2008 amid the global financial crisis. More recently, in 2019, despite Fed easing, the markets remained largely flat.
"Theory suggests a valuation boost; history augurs otherwise. In 2001, Nifty fell 35 per cent; in 2007, it melted up initially, but plunged 60 per cent in 2008" said the report.
The report also added that these varied outcomes highlight the importance of other factors, such as the state of the U.S. labor market, domestic demand, and market valuations, in determining how rate cuts impact the Indian equities.
As per the report currently several indicators from the U.S. labor market are flashing warning signs, suggesting economic challenges ahead. This scenario is notably different from 2007, when domestic demand was robust and contributed to the initial market surge. Now, however, domestic demand is weaker, raising concerns about the strength of economic recovery.
Furthermore, compared to 2019, market valuations are considerably more stretched, with equity prices appearing high relative to earnings potential.
The report added that these conditions warrant a cautious approach for investors, especially when it comes to sectors that have seen significant price appreciation. It noted the sectors such as industrials, public sector units (PSUs), automobiles, and metals, are particularly vulnerable.
It highlighted that this is reminder of the IT sector in 2001 and the broader cyclical sectors in 2008, both of which experienced sharp corrections after periods of overvaluation.
"Expensive cyclicals (industrials, PSUs, autos, and metals) are most vulnerable, a la IT in 2001 and cyclicals in 2008" the report added.
In light of these risks, many market strategists are advocating for an overweight (OW) position on defensive sectors. These include cash-generating companies, insurers, and private banks, which tend to perform better during periods of economic uncertainty.
While the possibility of outsized Fed rate cuts could provide some support to the market, the report stated that the timing of these cuts will be crucial in determining their effectiveness. Investors are advised to stay vigilant and consider repositioning their portfolios to navigate the potential volatility ahead.