Liquidity driven rally punctured: Economy hits a nadir

The writing on the wall was there for quite some time: But the bulls raged a fighting battle before succumbing to market realities. Both the front line indices suffered their worst losses in the past 12 months on 31st May 2013. The liquidity driven rally extended far beyond reasonable levels to 6230 on the Nifty. The jolt has come in the backdrop of dismal GDP numbers for India for fiscal 2012-13 and the noise by some Central banks on withdrawal of 'Easy money policy'. What to expect in the coming months for Indian equity markets?

Our markets would be driven by the following factors in the immediate future:

1. Global Liquidity: There are indications that global liquidity tightening would start soon as Central banks withdraw stimulus packages slowly. The Euro zone crisis will only deepen before a lasting solution is found for the revival of some member nations. Strengthening of US dollar would lead to a waning interest by FIIs in emerging markets like India.

2. India's Economic woes: India's GDP growth would continue to falter on the back of mismatch between supply and demand. The current account deficit (CAD) will continue to play a spoiler as exports stagnate despite Rupee hitting a low of 56.70/$ once again. A pick up in investment climate is still a far cry. Inflation scare continues to dodge the policy makers. Markets have tried to rally on the back of rate cut hopes, but no real rate cuts have happened despite a cut in Repo rate by RBI. This would make the bulls withdraw from the markets. The last quarter results of companies also paint a grim picture for the immediate future.

3. Fluid Political scenario: A lame-duck Govt. continues to survive amidst serious policy paralysis, as the opposition remains confused. The chances of any serious business being conducted in the monsoon session of parliament seem remote. If stars are to be believed there is a strong indication of announcement of mid-term polls before or after the monsoon session of parliament. If that happens we could witness Lok Sabha elections between 20th Nov-20th Dec. 2013, and the formation of a new Govt. By the end of December 2013.

All the above factors may lead to a serious erosion in equity indices over the next few months. The front line Nifty index could again go back to the levels of around 5500 soon. It could even test the level of 5000 in a short span if elections are announced in India or Ben Bernanke decides to withdraw the stimulus package.

'Contagion effect' could spell 'mayhem' for markets

Disclaimer: This write-up is not meant to scare investors, but enable them to understand ground realities and prepare them to take informed decisions on their investments.

 

Us equity indices are trading at all time highs and you thought that the global economy is in 'pink of health': you are mistaken. Bullion prices have smartly recovered from their recent lows and you thought genuine demand is back: you are sadly mistaken. Real estate prices have started firming up after stagnating for 2 quarters and all is 'hunky dory': you may be far away from reality. The month of May 2013 could lead to busting of many such myths and bring the world closer to reality. May may lead to 'mayhem' in the markets!

 

Let us understand the meaning of 'Contagion effect': According to Wikipedia Financial contagion refers to a scenario in which small shocks, which initially affect only a few financial institutions or a particular region of an economy, spread to the rest of financial sectors and other countries whose economies were previously healthy, in a manner similar to the transmission of a medical disease. Financial contagion happens at both the international level and the domestic level. To put it in simple words it can be explained as: 'When 'Uncle Sam' sneezes the 'Dragon' catches cold. Let us analyse the reasons that could pull all markets down in tandem.

 

Quantitative easing (QE): There have been three rounds of QE leading to pumping of liquidity into the markets to overcome the spectre of a recession. There was a consensus on the positive impact of QE1, whereas the opinion of economists was divided over QE2. But the consensus has been strong on the negative impact of QE3. Most economists believe that QE3 was responsible for excessive dose of liquidity in the markets which fuelled the prices of risk assets (Equity, bullion, real estate) to unsustainable levels. Now the markets are in a mood to correct these imbalances. The crash in Bullion prices is only the tip of the iceberg. Gold was traded at Rs.19500 per gram in 2011, so a correction to these levels should not come as a surprise to investors, after a temporary rebound. US equity markets have rallied to new highs despite serious questions on its growth prospects: a 10-15% slide cannot be ruled out. Real estate prices in Asia (more particularly India) are still quoting at unaffordable levels in most tier-I cities: a decent correction cannot be ruled out.

 

The trigger for a correction is most likely to come from Euro zone, which is on the brink of a major full-blown crisis. Indian markets would also have to contend with an uncertain political situation leading to the non-functioning of parliament/ dissolution of the Lok Sabha. Where would the money flow in such a scenario: The excess liquidity would definitely move into US treasuries leading to a strength in US dollar, which would weaken the commodity and equity markets. Gold & equity markets havs a potential to correct at least 20% from current levels: So don't be surprised to see Gold at Rs22000 per gram in Indian market, and front line Nifty at sub 5000 levels in this 'mayhem'. Realty markets could also stagnate for a few more quarters with tier-I cities bearing the brunt of the carnage.

 

The best investment strategy in such a scenario would be to sit on cash/ bank deposits, which can be profitably re-deployed once the downturn has played out. A real/ meaningful global recovery is still at least 2 quarters away. It may not be a bad idea to sell in the markets at current levels and go for a holiday in May 2013.

A 'Golden myth' shattered: Real Estate crash may follow!

The inevitable has happened: Gold & Silver prices have recorded their biggest single day crash in world markets today. Interestingly, media has got something new on its platter as compared to the boring debates on Narendra Modi vs Rahul Gandhi, none of whom is capable enough to become a worthy PM candidate of world's largest democracy.

 

The events of the past 2-3 days have shattered one of the most common myths cherished by many investors: "Gold prices can never fall''. Many such investors who put forth an argument in favour of investment in gold at ridiculously high prices was its 'safe haven' appeal and the limited supply, suddenly have developed cold feet and are quitting their gold investment in a hurry. The entire metal sector is witnessing a free fall due to escalation of the Euro zone crisis to alarming proportions. Indian economy is also in the grip of a massive slowdown, even as liquidity becomes tighter. The events of the past few days have started the exodus from physical assets which are held by investors till a panic situation is created.

 

Is this a precursor to the larger crash to follow? I am pointing towards a real estate market meltdown. If history is to be believed there are enough reasons for creation of a bleak scenario for the real estate crash in the near future. In a panic situation investors liquidate the most liquid assets first and illiquid assets are retained till the last. Real estate being the most illiquid asset, investors are still holding on to it, on the belief that they still have not lost money on their investment. This illogical belief is based on the artificial prices created by the builder lobby. The recent entrants to the real estate market will be the first to panic once they are faced with a liquidity crunch. The reasons for this to happen are very strong as the new real estate stock sold recently is almost entirely owned by speculators. End users have been left far behind in the race for owning their 'dream home'. The liquidity crunch coupled with an unstable political scenario is a perfect situation to create a crisis in the real estate market. In such a scenario first time home owners are advised to wait a while to get better bargains to suit their budget. It may not be a bad idea to strike a bargain to rent a property of your choice as rentals are on a southward journey. Commercial rental market is also showing signs of a massive slowdown. Those in need for owning a house may opt for 'ready to move in' properties rather than new projects which are being launched at unrealistic premiums during the festive season. Resale properties are available at 10-12% lower price point.

An economic recovery will not be sustainable without a real estate crash, as economic growth depends upon an orderly real estate market: both for individual home owners and corporate sector. Real estate must be available at reasonable prices to the end users. The asset class that will revive the risk appetite will be 'Equity'. Investors are advised to enter equity markets on declines as they drift lower in sympathy with commodity and real estate markets.

 

 

 

Extreme pessimism may push markets down: Investors advised caution

There is extreme pessimism in the markets, despite US equity indices making new highs. In my last post, four weeks back, I had anticipated the markets to correct to the level of around 5600 on the Nifty. The market has decisively breached the 5600 mark recently and is not showing any signs of a recovery soon. The underlying pessimism in the markets is a result of the following factors:

• India's economic recovery is still illusive. In fact fresh data is suggesting a further slowdown in growth momentum. Inflation is not coming down to reasonable levels and the Current account deficit (CAD) has blown to 6.7% of the GDP. Despite a falling rupee our exports continue to stagnate. There are serious supply side bottlenecks in core sector growth. Policy paralysis is making a heavy negative impact on the Infrastructure, Power & Mining sectors. New investors are shying away from investments in Indian projects. Even the FII flows are slowly turning negative.
• Political Uncertainty is likely to intensify in the days to come. This may lead to postponement of important economic decisions. The announcement of early General elections could dampen the market sentiment further.
• The news flow from Euro zone continues to caste its shadow on risky assets. The Cyprus issue could escalate  to a full blown crises for the Euro zone. There are other concerns too. North Korea continues to be 'Joker in the pack'. It has the capability to disturb the global equation, and may lead to military tensions with the west.

In the above scenario, the short term outlook for all risk assets (Equity, Bonds & Real estate) does not seem to be promising. We could soon see a panic situation in real estate markets as the liquidity is becoming tight. We could also  see a substantial fall in equity indices from the current levels. Equity markets could fall another 10% from the current levels and could stabilise around 5000-5200 on Nifty and 16500-17000 on the Sensex. A sudden declaration of war (by North Korea) or dissolution of Lok Sabha could have a knee jerk reaction on the equity indices which could take the Nifty to sub 5000 levels for a short while. If this happens it would be a really opportune time for investors to buy, as the indices would recover from their lows quickly. Investors are advised not to panic in the volatile environment and keep investing in front line  equity stocks on declines. Any short term bounce from the current levels towards 5750 on Nifty will be a good opportunity to book some profits & trim short term losses. An early election will be positive for the long term revival of the Bull market in India. If that happens we could see a sharp turnaround in equity markets in the 2nd half of FY 13-14.

Where to invest: Physical vs Financial assets

Physical assets are plant, machinery, land, building and bullion (gold /silver) e.t.c where as financial assets include cash, bank deposits, shares, bonds, marketable securities. Financial assets are used to purchase physical assets. In the past few years Indians have shown a marked preference towards holding physical assets over financial assets. It is believed that immediate past performance is a reason for marked preference for physical assets.  On the other hand, ownership of Indians, excluding promoters, in Indian companies (equities and mutual funds or MFs) has steadily declined over the last two decades. If we compare the returns: real estate investment has fetched an average annualised return of 27% since 2005. Gold has also given a 20% plus return over the past 3 years. Where as, broader equity markets have still not crossed the peak attained in January 2008, several midcap stocks have given huge negative returns during this period. No wonder, retail Indian investors have moved away from equity investment. On the other hand, blue chip Indian companies have been the preference of FII's during this period. Let us try to understand this paradox, in the back drop of evaluating the future prospects of equity investment vis-a-vis investment in physical assets.

 

Investment in financial assets has been, by and large, restricted to bank deposits because of the reach of the banks. On the equity side, despite the presence of several stock broking outfits and Mutual fund distributors, many of them facilitate trading rather than investing.  Investment in equities and MFs is perceived to be risky, where as gold and real estate get importance because of the social and cultural needs and aspirations.  Equities have not caught the fancy of investors even though long-term capital gains are tax-exempt. Lack of sophistication among Indian investors has allowed higher investment in gold (despite high impact cost of buying gold in jewellery form, quality issue, limited liquidity) and real estate (despite issues related to pricing, delivery, high impact cost of transaction and liquidity). Non performance of Indian equity market in the past 5 years is also driving investor preference towards gold and real estate.

 

Considering the above facts where should the investor put money in 2013?. Let us analyse the prospects of these asset classes over the next 5-7 years:

• Real estate: Indian real estate market has thrived on the lack of transparency in transactions coupled with speculative investment due to high global liquidity. Investment by end users is steadily declining due to exorbitant prices. Builders are saddled with huge unsold inventory, and over 50% properties sold have been lying vacant in premium markets like NCR. This is a bubble in the making. The prices have started cooling off, and the average returns expected in large pockets will reduce to single digit in the days to come. The speculators will be forced to distressed sales as global liquidity declines. We cannot expect double digit returns (net of the holding cost) from real estate in the years to come.
• Gold: Although gold has given phenomenal returns over the past decade, the gold cycle seems to be petering out. International prices of gold are stagnating in the $1500-1600/ ounce range, but prices in India have given a 20% return in past 2 years, mainly because of Rupee depreciation. As the investment cycle turns positive from 2nd half of 2013, Indian rupee would strengthen, pushing down gold prices in India. Gold might give a negative return during the year, in such a scenario. Tough measures taken by the Govt. to discourage gold imports might dampen the sentiment further in India.
• Bank deposits: The lure for safe investment will continue to provide a reasonable growth in bank deposits despite a negative inflation adjusted return. A fall in inflation rate will be a huge positive for growth in bank deposits.
• Equity: Despite giving a 25% return in 2012, equity investment has still not caught the fancy of Indian Investor. He has been consistently selling his stake in Indian companies to FII's. Equity investment is largely influenced by the earnings cycle which is likely to turn positive from 2nd half of 2013. The major reasons for this expectation stem from a falling inflation and falling interest rate regime. New investments would spur economic growth after next general election. We could see a mid term poll during 2013. My expectation from equity markets for next couple of years is a 18-20% annualised return, and we could see equity markets/ indices doubling from the current levels in next 4-5 years. However, in the extreme short term I expect the equity markets to settle lower at around 5600 on Nifty, or little lower. A sustained up move will unfold in the 2nd half of FY13-14, after prolonged consolidation.

To sum up, I foresee a decisive shift in favour of Financial assets over Physical assets during the next 12-18 months, as the returns from Real estate and Gold languish and equity markets start to out-perform.

 
 

 

 

 

Budget Blues: Golden opportunity to invest in equity

Budget session has brought a welcome correction in the equity markets. The correction that commenced with the presentation of Railway budget got accentuated with the presentation of General budget. However, the budget of the Union govt. cannot be blamed for the debacle. As mentioned in my last post the markets had run up ahead of fundamentals and were ripe for a decent correction. Unecessary hype was created in the run-up to the budget, disregarding the fact that the FM did not have enough leverage to offer any fresh sops to the stock market. The markets have reacted with a negative view on the budget, although the budget does not contain any major negatives for the markets. The lower GDP figures for Q3 have added to the markets woes.

The speculative positions in the market have been cut, in the backdrop of the unrealistic expectations not having been met by the FM. As indicated by me earlier, markets have corrected to reasonable levels and would consolidate around 5600 levels on the Nifty (18500 on the Sensex). According to me these levels are decent levels to accumulate good stocks with a one year perspective and with reasonable expectations of a 15% return by next budget. As speculative positions get cut, the ownership will slowly get transferred into safer hands, which augers well for the future of equity markets.

We must remember that the current budget has been presented in trying circumstances, and the FM must be congratulated for not dancing to the gallery in the election year. The most important aspect of the budget is the resolve towards imposing a pragmatic approach towards fiscal consolidation. If the FM can curb the Fiscal deficit, everything else will fall in place. This augers well for the future of equity markets. Investors are advised to put money into equities now, and wait patiently for markets to consolidate around the current levels for a while. The next major cue for the markets will be the FY 12-13 results of India Inc., which will start flowing in from the middle of April 2013.

Equity Markets poised for a correction

Indian equities have seen a spectacular run in the first month of 2013, thanks to the continued support from Foreign investors. Although the long term trend for our markets is definitely up, the market signals are pointing towards a 8-10% decline from the current levels in the short term. What are the factors that could induce the anticipated decline?

• RBI has obliged with a 25 bips Repo rate cut coupled with a 25 bips CRR cut as per market expectation. It has also indicated that there is little scope for further cuts in the immediate future.
• The major indices have been maintained at the current levels with the sector churning by large players. With the result season coming to an end there is little scope for the churning to continue.
• The advance-decline ratio has been under pressure, with mid caps showing vulnerability to hold on to the current levels. The fragile nature of mid cap momentum stocks is likely to give way to a decent decline once the front line stocks exhaust their momentum.
• The Indian economy continues to be plagued with severe supply side bottlenecks. The capex cycle is yet to pick up despite right noises by the Govt. Most of the recent policy initiatives have remained on paper only.
• The dis-investment cycle of Govt. in coming days will put pressure on the secondary market, as much of the liquidity will be sucked into the large dis-investment planned by the Govt.
• The market players will now await indications from the General Budget to be presented on 28th February. The markets would be on their tenterhooks before this major event, as the chances of a hike in tax rates is very much inevitable.

All the above factors indicate sluggishness in the markets. Investors are advised to book some profits and wait for the levels of 5600-5800 on Nifty (18800-19200 on Sensex) to re-enter again for long term.