Equity markets are overheated: Do not reflect Economic fundamentals

Indian equity markets have entered a danger zone, and a severe fall can not be ruled out once global liquidity dries up. Equity markets made new highs today with Nifty touching 8800 during trading hours. Markets seems to have discounted all the good news, however, seem unconcerned about the impending domestic & global concerns at this juncture. Most of the analysts are misleading the common investors by giving absurd targets for the indices in the days to come. I would like to caution the investors about the challenges faced by the global economy, which are likely to have an adverse impact on our equity markets.

Domestic issues: The GDP figures for the first quarter of this fiscal, released in the evening, have exposed the weakness of the economy. GDP for Q1 has slipped to 7.1% as compared to 7.9% for the previous quarter (Q4 of FY 2015-16). Industrial growth is down to 6%, Agricultural growth is down to 1.8%. The day has been been saved by Service sector growth at 9.3%. More worrying news comes from the Fiscal deficit front where the Govt. has reached 73% of the budgeted target within the first 4 months of the year, implying that it will exceed the Fiscal deficit target by a huge margin. Despite passing of the GST bill, the Govt. is not fully prepared for its roll-out from April 2017. The prediction for an above normal monsoon had been discounted by the market, but the progress of monsoon reveals that its distribution has not been up to the mark. The markets are again irrational in discounting the impact of  'Arrears paid to Govt. employees' as the same is likely to be inflationary in nature.

Global scenario: The global markets are flush with stimulus funds which are driving equity markets to crazy levels, far ahead of fundamentals. I would like to mention 3 inflection points which would lead to a negative slide in our markets:

1. Interest rate hike by US Federal Reserve: The oft postponed rate hike is now inevitable, it is likely to be announced in September. This will lead to strengthening of the US $, leading to the flight of capital from equity markets to safe havens like US treasuries, Gold & Silver. It would also have a negative impact on our already shrinking exports to developed markets

2. Impact of Brexit: As euro-zone prepares for Britain's exit, the instability would lead to drastic cut in Capex budget in the euro-zone and consequent decline in IT exports to these countries from India. New regimes in UK and US are seen moving toward stringent immigration laws, leading to a fall in global Indian companies operating in or supplying to these countries.

3. Financial turmoil in China: China's growth has been an enigma for the entire world, but now the cat is out of the hat. The next round of global instability is likely to be inflicted by China, as the country's debt has been mounting to unreasonable levels. China may resort to further devaluation of its currency to stem the rot, but it may have a cascading effect on developing markets, and India is unlikely to be spared.

In such a scenario our equity markets will need to correct substantially, to make them reasonably priced (Nifty index currently trades at a PE multiple of over 23, as against the average of 14-16). Nifty index has had a non-stop run from 6825 to around 8800 within the past 6 months. A reasonable correction from these levels would take the Nifty in the range of 7800-7900 levels (a 50% retracement of the recent rise). Investors are advised to book substantial profits at the current level, and wait for a correction to around 8000 levels on the Nifty to re-enter again. The fall in Mid-cap & Small-cap stocks could be much deeper.

India's GDP Growth: Myth & Reality

If statistics are to be believed, Indian economy has become the fastest growing economy in the world, raking in a GDP growth rate of 7.6% in FY 2015-16. What is even more shocking to digest is the GDP number of 7.9% for the 4th quarter ended March 2016. Many economists are scratching their heads in disbelief at one of the biggest 'economic fraud' of the Govt. of India. A section of media and the crony capitalists may be singing praises for the Govt., but the figures simply do not add up. Here are some bitter facts about the real economy:

• 2/3rd of the population living in rural India continues to be in extreme distress
• Salaries may have gone up in urban India, but high food inflation is keeping the folks unhappy
• Even the benefit of low crude oil prices has not been passed on to the people: Petrol is back at Rs.70 a litre
• Most corporate houses are shying from fresh investment as the profit margins have shrunk to multi-year lows
• Bank's have been unable to pass on the benefit of low interest rate to the population as they are grappling with the worst NPL crises.
• Exports, imports and remittances from abroad are sharply down
• The manufacturing PMI of 50.7% for May 2016 is the lowest in the past 5 months
• Growth in public spending, which should act as the key driver of growth, marked a sharp drop by 5.4% in fiscal year 2016 
• Employment growth plunged to a six-year low in 2015 across the eight key labour-intensive industries and only 0.1 million jobs were created last year.

The above data highlights the real report card of the present Govt., at a time when it is celebrating completion of 2 years in office. The Govt. has failed to provide any economic stimulus during the past 2 years. Private consumption has been calculated to have grown by a whopping Rs.1,27,000 crores without any evidence supporting the figures. Many economists argue that there are anomalies in the new series of GDP estimates released in January 2015. As per the old methodology Indian economy may have barely grown by 4%, or half of what has been reported recently. The economic jugglery or the biggest 'data fudging' may soon be questioned at international forums, and India may risk a downgrade in its sovereign rating.

There are 3 main culprits responsible for India's current dismal economic situation:

1. Arun Jaitley, FM: A man without a political stronghold, who never won an election and yet catapulted to the position of FM, he has failed to handle the situation effectively, despite the windfall received due to the crash in global crude oil prices. During his tenure rural demand has slipped to its lowest ever, and consequently fresh investment has struggled. He may turn out to be the most incompetent FM India ever had.

2. Subramaniam Swamy: The loose canon of BJP, who has prepared the ground for passing the buck of Govt's economic failure at the doorstep of the RBI Governor. The man chosen by BJP to counter the Gandhi family may turn out to be an embarrassment for the party.

3. TCA Anant, CSO: For doing the data fudging at the behest of his masters, Modi and Jaitley.

The Govt. may be relying heavily on the better monsoon forecasts for the current year for a turn around in its fortunes, but there are far too many other factors like the distribution pattern, which play an important role in the overall impact of the monsoon on the economy. Relying merely on a single factor for a turn-around could be asking for further trouble. A lot needs to be done by the Govt. on the economic front, before it is too late, they need to compensate for the uneventful first 2 years in office.

Equity markets on 'Tenterhooks' on Financial sector flip-flop

The short term recovery in our equity markets that brought the Nifty close to the 8000 mark, failed to sustain as Financial sector outlook remained uncertain. Nifty did make a smart come back from the levels of 6825 touched on the budget day, but the status-quo announced by Bank of Japan (BOJ) on quantitative easing took the wind out of the markets. On the other hand, weakening of the dollar (after taking ques from BOJ) stretched the rally in gold as the precious metal traded close to the 1300$/ ounce mark. We have seen a sharp decline in global equity markets towards the end of the month. Our markets have other issues to digest beyond the weak global signals.

The most important question for our markets is the Health of our Financial sector. The dilemma before the analysts is to decide whether the declaration of bad loans in the balance sheets of Banks (responding to the dictat of the Central Bank), and the corresponding hit on the bottom line, a positive development or it should be treated as alarm bell for the health of the Financial sector. As at the end of December 2015 the gross NPAs of 39 listed entities of the banking sector amounted to over Rs.4.38 trillion. And a staggering Rs.6 trillion is classified in the categories SMA 1 & 2, a portion of which will definitely find its way to the NPA category over the next financial year. 

To add to the woes of the Banking sector is the alarming situation existing vis-a-vis NBFCs (there are over 11000 NBFCs registered with RBI). As per RBI's report on NBFCs, where the norms for NPAs are less stringent as compared to banks, they have 3.5% bad assets on their books. The sectors contributing towards the stress assets are: Infrastructure, Steel & Power to name a few. 

With the economic revival still at least 2-3 quarters away, the stress on the books of Financial sector companies is only going to escalate before it begins to decline. Given the acute drought situation prevailing in the country, something more that an above normal monsoon will be needed to help the Financial sector overcome its current set of woes. The equity markets have perhaps sensed the alarming situation, and are likely to remain subdued in the immediate future. A marked improvement in the market fortunes is linked to a meaningful turn-around in the health of the Financial sector. 

Will Emerging Markets bounce back in 2016?

Emerging markets (EMs) have had a bad yearly performance in 2015. Most EMs, including India, have delivered negative returns this year. Most of these markets are facing turbulent times due to various global/ domestic reasons. Brazil and Russia have been adversely affected by the consistently falling commodity prices. China has been struggling with a readjustment in its consumption theme leading to a sharp dip in its GDP. India, though taking a positive from the sharp drop in commodity prices (especially crude oil), has received a setback due to domestic factors like high inflation and political logjam. 

Analysts are now hoping that most emerging markets would find their bottom soon, and latter half of 2016 may see their revival. The uncertainty over hike in US Fed Rate is over and most emerging markets have responded positively to the event. The Indian Rupee has appreciated a bit and is now hovering around the Rs66/ $ mark. The stability of the Rupee is a good sign for our economy. The commodity markets are close to their bottom. Although lower commodity prices may seem positive for India, indirectly they lead to lower demand for Indian exports as the commodity exporting countries loose their competitiveness. Thus any further fall in commodity prices is not desirable for the global economy.

India is better placed than most emerging markets due to the revival of its domestic consumption story. There have been some green shoots of revival of consumer demand in urban areas, though rural demand is yet to pick-up steam. The pay hike for Govt. servants may boost the economy in the next fiscal. The passage of interest rate cuts by RBI will gain momentum in fiscal 2016-17, which will be a major force in revival of the earnings cycle. The clock seemed to have turned full circle for the markets, which are likely to stabilise in the range of 7500-8000 on the Nifty, before making the next up move. Surprisingly, the broader markets have performed much better in the recent down turn, and this augers well for a market rebound, sooner than later.

In conclusion, retail investors are advised to get ready for a revival, and continue to put money in the markets slowly, SIP would be a better choice. 2016 promises to be a better year for equity investment as compared to 2015.

RBI signals the end of 'Bear Market' in India

RBI Governor Raghuram Rajan sprang up a pleasant surprise handing over a Diwali gift to the market/ investors, by lowering the benchmark Repo rate by 50 basis points to 6.75%, in the bi-monthly monetary policy announcement on 29th September. The benchmark rate is now at the lowest in 4 years. This has ushered an era of benign interest rate scenario in the country over the medium term. Although, our equity markets may swing widely based on international cues, this action will serve as the most important catalyst for laying the foundation of a long term bull market in India. 

Let us analyse the implications of the policy announcement:

• The Governor has articulated his intention for working with the Govt. to ensure transmission of the rate cuts by the Banking system
• RBI has lowered the forecast for GDP growth from 7.6% to 7.4% for FY 2015-16, focusing on an urgent need to boost investment/ growth
• Inflation projection for January 2016 has been projected at 5.8%, against the previous estimates of 6%, based on benign commodity prices
• To improve liquidity with the banks, RBI has proposed a reduction in SLR by 1%, in a phased manner.

The single most factor responsible for valuation of stocks in the market is the earnings estimates. Unfortunately, earnings growth has been muted due to two factors: Excess capacity/ low consumption and Cost escalation due to high Interest rates. The lower interest rate regime will help the high debt companies to save substantially on interest service cost. Consumption led growth will have to be given a boost by Govt. spending. The size able saving by the Govt. on Commodity/ Oil imports will help the Govt. to increase spending.

The timing of the rate cut is perfect, as it coincides the busy festival season, which is an opportunity for Corporate India to boost its sales (top line), the profits (bottom line) will improve with largess's doled out by RBI. Banks have started responding to the RBI gesture by lowering their base rates, SBI taking the lead by lowering its base rate by 40 bips to 9.3%.

I can safely say now that the bottom of our markets has been made at around 7500 on the Nifty, although, in the short term markets may swing widely between 7500-8200 on the Nifty, based on global cues and expectations of lower earnings for quarter ending September 2015. However, it is expected that the earnings growth will improve steadily from December 2015 onwards, and the same will reflect in the growth of the bench mark equity indices thereafter. Now is the time to invest in the equity markets for long term, provided investors are ready to brave the short term volatility over the next 3 months.

Equity Markets hold their nerves in Turbulent times

July 2015 proved to be an eventful month in the history of Financial Markets: World markets oscillated between hope and despair as the 'Greek Paradox' and the 'Chinese Nightmare' unfolded amidst extreme uncertainty. After days of claims and counter claims Greece was granted another bailout by the European Union with some tough terms for the revised package. A crises has been postponed for the time being. But the bigger jolt came from China, as news of a major Chinese slowdown made severe dents in the commodity markets. All commodities fell in tandem as the US Dollar hit new highs exerting pressure on Gold, which hit multi year lows and slipped below the $1100/ ounce mark. Other metals in the metal pack hit new multi year bottoms as slowdown in China became evident. Crude oil continued its unabated southwards journey slipping below the $50 mark for 2nd time during the year.

 

Events on the domestic front brightened for India due to the soft commodity prices, but our politicians continued to play hide and seek by disrupting parliamentary proceeding day after day. The fate of several crucial bills including GST, Land Bill etc. still hangs in balance. The saga of Q1 results presented a mixed bag with muted growth in profits for a majority of the companies. While IT sector surprised with better than expected results, the Pharma majors and PSU banks disappointed with a drag on their bottom lines.

 

Markets remained resilient through the July mayhem, and have begun the August series on a positive note. Most analysts are again sounding positive on the future growth of our equity markets, based on the following reasons:

• Monsoons have picked up contrary to the dismal forecast, and sowing of crops has been good in most parts of the country
• Greece has reached an agreement with EU which augers well for the Euro-Dollar stability
• Passage of GST bill may prove a sentimental booster for markets
• EPFO would start investment in equity markets from August
• However, bottom lines would start improving from December quarter only

Our markets may have made a bottom at around 8000 levels on the Nifty. A retest of these levels may not be ruled out in case of extreme pessimism. Otherwise, we can hope to see substantial re-rating of our markets in second half of this fiscal, when the positive effects of soft commodity prices and low interest rate transmission would be visible. Given that China will considerably slowdown India may find itself in a sweet spot. This augers well for our equity markets in the medium to longer term.

 

 

Greek default: Consequences for India

Greece has finally become the first developed economy in the world to default on IMF repayment. However, the stock markets around the world have taken the event in their stride. There was some selling of stocks around the world, but the euro itself was stable in currency markets and the main index of financial volatility (Vix) was much tamer Monday than it had been in some acute earlier phases of the crisis. Majority of global investors, seem to think that the European Union and the European Central Bank have the tools in place to contain any financial fallout from a Greek default and exit from the euro.

 

Our markets are also expected to rebound in the short term, simply because the looming uncertainty in now over, or at best would get over after the Greek referendum result on 5th July. In a way it is good that the Greek creditors have said no to the Greek bail-out, strengthening the cause of imposing financial discipline on errant borrowers. With the exit of Greece from Euro zone, which seems inevitable now, ends the ill-conceived dream of having a common currency- 'Euro'. In the medium term, it is likely to have an adverse impact on companies having a large chunk of their revenues from the Euro-zone.

 

India need not worry too much about the consequences of the Greek exit. On the other hand, India needs to focus on its own problems. The Govt. continues to roll out new campaigns one after the other, Digital India being launched on 1st July, but it is unable to arrive at a consensus with the opposition on passage on important bills in the parliament. The monsoon session of the parliament promises to be lack lustre unless some serious efforts are made by politicians to sort out their differences. The setback to the prospects of bountiful monsoon rains is looming large over the revival of the rural economy. A temporary rebound in our markets should not be seen as a return of the bull run. We must brace for an extended summer of discontent, before autumn brings some cheer to the markets. It would be a better option for investors to sit on the side lines and wait for the 'green-shoots' of economic revival to emerge.