The equity markets have scaled new highs, with the outlook for the domestic economy quite stable and robust, given the state of the key macroeconomic indicators. The domestic investor interest has been high with the net inflows into equities through funds, in the phased investments mode, has been going up. What is giving support to the markets is the strong economic growth and the prospects for earnings growth too, which the market has been busy pricing in. In the view of the traditional monetarist school led by Milton Freidman, the social responsibility of a corporate is to make more and more profits. So long as corporates make profits there is no reason why the markets should not reflect that. What gives stability to growth is the stable contribution of the primary sector or agriculture to the overall growth even in times when there was uncertainty regarding growth. This is expected to be retained with more or less near normal monsoons, and sowing season, and crops. Despite the second wave of the pandemic, the corporates have managed things well, mainly from the experience from the first wave where the accent was on operational efficiencies. The benefits of the PLI scheme as also the broad recovery seen in global economies is going to provide a further impetus to growth in the domestic economy. But we need to be seized of the two risks to growth and higher markets at this juncture. The first is the price level or inflation. Inflation has come down to 4.35% in Sept mainly due to the fall in the prices of fruits and vegetables. But the rise in oil prices, Brent, to US$ 85 is a sharp rise, and it seems to be poised to move up in the perception of many oil analysts. With a weakening Rupee the higher oil prices may compound the issues further if it rises to the discomfort of the RBI leading to a modification of the interest rates. While the focus of the RBI is currently on normalization of liquidity, any movement away from this and on to rates may make the cost of funds more expensive and could impact some of the corporates who have debt on their books. Apart from all this, there is a saying that higher prices is its own cure. This is because inflation leads to a fall in consumption and aggregate demand, and thereby, a slowdown in inflation. Inflation affects the economy adversely as it kills demand, through higher price level which disincentivises consumption and also through higher cost of funds with rise in interest rates. As the market continues with its upward trajectory,
with rising prices, the probability of a corrective downward movement becomes higher compared to the potential to move up. Apart from the inflation factor, the likelihood of the Fed initiating the tapering of bond purchases by November, and the prognosis for the Dollar to firm up further, may have its consequences for emerging markets and their currencies. At this juncture phased investments into large caps and mid- caps, and also balanced advantage funds may be considered.