Stock markets across the globe fell sharply over the last few months at the slightest mention of a taper in the US. On Wednesday, when the US Federal Reserve actually announced a reduction in bond purchases by $10 billion, the Dow Jones and the S&P 500 benchmarks in the US closed at record highs.
(Read: Dow, S&P end at record highs after Fed trims stimulus)
Here's why:
The quantum of reduction in bond buying was along expected lines. Further cuts will take place throughout next year and only if the US economy shows continued improvement. So, easy liquidity continues for now.
Fed adopted a more dovish outlook on interest rates. It now plans to hold its key short-term rate near zero at least until unemployment falls below 6.5 per cent.
The Fed believes the US economy is turning around. It estimates 2014 growth between 2.8 per cent and 3.2 per cent as against 2 per cent in 2013. So, corporate profits may rise.
(Read: 10 must-know facts about stimulus tapering)
Markets hate uncertainty. Fed's decision will halt further speculation on liquidity and stocks will move closer to fundamentals.
What about India:
Like their US counterparts, Indian stock markets are trading near record highs. However, there's limited optimism about the Indian economy, which is currently growing at the slowest pace in a decade. The government is looking to cut expenditure to rein in high fiscal deficit. Elections are due in May 2014, so there's little scope for policy action. Finally, the stubbornly high inflation leaves little scope for monetary easing to kick-start the economy.
Foreign institutional investors (FIIs), who are the biggest drivers of Indian stock markets, have been putting money in India so far because of easy liquidity. Now, the situation might change. US markets will become more attractive and there might be a flight of capital.
The rupee is also likely to come under pressure. India's current account deficit has come down sharply and for the full fiscal CAD is expected at less than 3 per cent of GDP (as compared to 4.8 per cent in 2012-13), but heavy selloff by FIIs may pressure the rupee. And that in turn will drive stocks even lower.
There will be hardly any support from domestic institutions who have been big sellers in Indian stocks. As a result, there might be major turbulence for Indian stocks ahead.